Creator: Kevin Lu, Senior Fellow, Milken Institute, Akanksha Madan, Pupil Researcher, Yale-NUS
- Co-investing is a monetary mannequin that sees smaller buyers collaborate with bigger companions, avoiding charges, exchanging information and opening up new investments.
- In 2012, 24% of Restricted Companions used co-investment. In 2021, that determine was 71%.
- Prime buyers have shared their recommendations on how greatest to method touchdown a co-investment deal.
Co-investing as a method has been on the rise for years.
A pattern documented by the World Financial Discussion board, co-investing as a mannequin sees Restricted Companions (LPs) take a direct stake, or ‘co-invest,’ in a selected asset together with their Basic Accomplice (GP) — usually a bigger institutional investor — over and above their funding within the GP’s funds.
Up to now decade, co-investing as a method has taken the world of personal fairness financing by storm. In 2012, 24% of Restricted Companions utilized co-investment of their portfolios. In 2021, that determine was 71%. Co-investing is changing into a should for buyers all over the place.
Co-investing has usually been perceived as an LP-led train used to cut back general charges in non-public fairness investing — that’s not improper, however it isn’t the entire story.
Analysis exhibits that LPs are motivated by extra nuanced elements. For instance, past the extra bottom-line-driven causes like threat administration and growing allocation to alternate options, analysis signifies that LPs hunt down the trade of data with their GPs. In reality, some LPs’ major motivation to co-invest is to work with and study from their greatest managers about industries, traits and greatest practices.
GPs additionally acknowledge the advantages of co-investments. An LP can present helpful capital for an enormous deal for which the GP’s personal funds might not be adequate, or the deal measurement is above the fund restrict for a selected business or geography. Most significantly, GPs would quite share such offers with their LPs than different opponents.
The clear advantages of co-investing imply competitors amongst LPs for a GP is fierce. LPs have a ravenous urge for food for co-investments – a few of the largest LPs, with cheque sizes of over $500m, view fund investments as a way to the top of co-investing. They need a 1:1 fund to co-investment ratio or extra. On the similar time, 37% of LPs cite an absence of obtainable alternatives as a hurdle to co-investing.
Many GPs complain that their LPs demand co-investments however don’t have the capabilities to help the method.
GPs now interact in an implicit choice course of that favours confirmed LPs. With a number of LPs capable of minimize a large cheque, they need to now compete to entry the most effective alternatives with their greatest GPs.
Touchdown the deal
Researchers on the Milken Institute’s Asia Middle interviewed the Chief Funding Officers (CIOs) of 8 massive sovereign wealth and pension funds. Beneath Chatham Home guidelines, the CIOs — who collectively handle investments price over $2.4 trillion — shared what LPs can do to land that deal.
1. “Go from constructing enterprise relationships to strategic relationships with GPs”
Profitable LPs recognized the GPs they believed in and nurtured relationships with them. One LP did this by changing into a trusted advisor. When a GP was elevating a brand new fund, this LP suggested them on the fundraising panorama, which led to the GP altering their technique.
One other investor sends the reverse deal circulation to chose GPs, sharing good offers they’re unable to pursue. Equally, an insurance coverage fund, half of a bigger company, helps set up enterprise partnerships between GPs’ portfolio firms and their very own subsidiaries.
For co-investments particularly, one pension fund commits to investing 10-15% in new funds launched by their GPs in return for co-investing. Additionally they decide to supporting GPs on offers that don’t match neatly in a single asset class — equivalent to complicated offers with a credit score element — and are sometimes rejected by different LPs for that reason.
This LP even went so far as to say: “Occasionally, we could settle for a decrease yield on a deal as a result of the deal itself is sweet for us.”
2. “A agency sure and a fast no”
After closely investing in constructing relationships with choose GPs, profitable LPs act with agility through the co-investing course of itself.
“We comply with the easy rule of a ‘agency sure, fast no’ when introduced with co-investments. We can’t say sure first after which convey up a day one situation in week 4,” stated a sovereign wealth fund that has change into one of the crucial lively co-investors globally.
Equally, to change into extra agile, a pension fund altered their governance from requiring board approval for particular person offers to permitting funding groups to make choices. They stated: “Our board meets 5-6 occasions a yr. If you happen to’re sure to that schedule, decision-making takes plenty of time.”
On the similar time, to uphold their governance requirements, funding groups solely have decision-making autonomy for offers with an outlined group of strategic companion GPs.
3. “Don’t insist on being within the negotiation room on a regular basis”
Within the interviews, LPs emphasised the significance of sustaining belief all through the co-investing course of.
They introduced up particular examples of unhealthy practices that they had witnessed and actively selected to keep away from, equivalent to demanding unsound phrases from GPs. Additionally they stated it was unfair to say sure initially after which change their thoughts if the market sentiment adjustments 4 weeks later.
“Drop the ego. Belief that your GP represents your pursuits,” stated one investor, who added there was no want for them to be current within the negotiation room all the time or attempt to dominate the negotiation in a syndicated deal.
These suggestions ought to assist any LP construct their observe file and efficiently take part in co-investments.
On the finish of the day, non-public fairness is a relationship enterprise, and the connection between an LP and GP turns into much more necessary through the co-investing course of.
LPs who succeed will acknowledge and act upon this, generate superior returns and construct a future-ready portfolio in flip.