Enabling Private Equity Firms to Ride the Co-investment Wave

Published on January 5, 2017 by Ambarish Srivastava

Co-investment deals are turning a new leaf in private equity investing. After years of investing through General Partner (GP)-led funds, investors or Limited Partners (LPs) have increasingly started to express their concerns over the traditional LP-GP fund structure, which has left them at a disadvantageous position. LPs had to be content with agreed returns under standard fund structures, such as the 2/20 fee structure, while GPs retained all upside, most notably arising from supernormal returns on a few investments. This dissonance has led LPs to demand co-investment opportunities with GPs as they seek higher returns on their capital. Over the years, such deals have increased in value as well as volume.

Evidently, LPs are lured by higher returns, reduced fees, greater control on their capital, developing expertise in specific sectors or investing styles, and transparency associated with such deals

On the other hand, as curious as it may sound and astonishing it may appear, GPs are offering more co-investing deals to investors despite losing on lucrative fees. A key driving force behind this shift in behavior is the increasing competition in the fund-raising market – competition for funds has become tougher, leaving GPs with limited choices but to build and strengthen relationships with key investors and LPs by offering participation in lucrative investment opportunities. These relationships are also quite useful for private equity (PE) firms as they help generate references and enable them to identify and expand investor base. According to Forbes, about 80% of investors are investing larger amounts with fewer selected managers. In fact, Pepper Hamilton believes 62% of co-investing opportunities emerge from existing GP-LP relationships.

On a positive note, GPs can mitigate and share investment risks with LPs while retaining control on investment decisions. At times, LPs can also bring required expertise in a particular field.

Yet, the investment life cycle of co-investment deals is saddled with additional challenges for GPs. They have to deal with additional decision makers, such as investment committees of LPs in addition to their own and more participants from LPs in investment discussions, and need to keep all stakeholders informed on portfolios’ performance and other developments. This inadvertently translates to increased workload both in conducting investment due diligence research and LP-reporting at times in formats required by LPs. The ever-changing regulations that require compliance reporting on fee and expenses further add to complexity.

As an outcome, GPs face pressure to deploy more of their available team’s bandwidth and resources in executing such co-investment deals without compromising on any other critical fund activities such as deal sourcing, executing other deals, or monitoring portfolio investments. Fortunately, they have options – the KPs (Knowledge Partners)!

KPs provide GPs with flexible bandwidth to undertake any or all incremental research and reporting tasks arising from co-investment situations. Several PE firms have already associated themselves with KPs and leverage them on a wide range of investment life cycle support tasks. This association has helped GPs build trust on the capabilities of their KPs, especially with regard to the quality and insightfulness of their work, and view them as natural extensions to their own teams. These KPs are now enabling GPs to ride the co-investment wave without causing too many ripples across their own organization structure and investment process.

Acuity Knowledge Partners has extensive experience in partnering with PE firms to optimize their investment screening, due-diligence, portfolio monitoring and reporting tasks, and this positions us favorably to offer invaluable support to GPs in executing co-investment deals, as they seek to build long lasting relationships with LPs

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