The market in private equity, venture and real estate investing is increasingly favouring co-investment structures, allowing investors to invest alongside more traditional blind pool funds. Here we discuss the key features of such structures, why they are becoming increasingly popular and a few risks to be wary of.
Fund managers are increasingly seeing an appetite amongst larger investors for their capital to be invested through a co-investment structure, either alongside the manager’s main fund, or as one in a number of co-investment vehicles which fund investments originated by the manager on a deal-by-deal basis. A sizeable co-investment mandate assists the manager to fund larger deals and potentially gives it access to fees and/or carried interest on those deals (although typically at a lower rate than from the fund itself). It also gives the investor a larger exposure to the market than it may get through investing in the fund alone.
Co-investment vehicles also allow the manager to offer favourable terms to the co-investor through the co-investment vehicle, often outside of any most-favoured nations obligations which they may be subject to within the fund itself.
Structural and other considerations
However, both managers and investors need to approach such structures in an informed manner:
- The manager should only be offering co-investment opportunities on a strategic basis, and not to the detriment of the fund’s own investments. An obligation built into fund documents or side letters requiring a certain portion of any deal to be offered to particular co-investors may operate to the detriment of the manager’s main fund vehicle.
- The manager will also need to bear in mind the practical impact which a series of co-investment obligations may have on its deal execution. Certain difficulties can be avoided by using a syndication model, but the general partner must then be conscious of the risk that particular deals cannot be syndicated as planned.
- The manager must ensure that it has the correct regulatory permissions to manage co-investment mandates (the management of single investor co-investment vehicles will probably not be covered by an AIFMD licence).
- Investors must be comfortable that they have the necessary level of internal expertise to be able to assess and execute co-investment opportunities.