Co-investment funds have become an increasingly popular form of alternative investment in recent years. As the name suggests, they involve investors co-investing alongside an experienced private equity or venture capital fund into an underlying portfolio company. This provides investors with access to deals they likely couldn’t access on their own. There are several potential advantages to co-investing, including reduced fees, greater potential returns, and closer relationships with fund managers. However, there are also risks such as lack of diversification and illiquidity. When structured properly, co-investment funds can be an attractive way for qualified investors to gain exposure to private companies and tap into the expertise of top-tier investment funds.
Co-investment funds provide access to deals regular investors can’t access
One of the main appeals of co-investment funds is that they provide access to deals that most investors would not be able to access on their own. Private equity and venture capital funds source proprietary deals by leveraging their networks and investing experience. By co-investing alongside them, investors gain access to these exclusive opportunities that they likely wouldn’t see otherwise. For example, a pension fund may co-invest in a late-stage technology startup alongside a top-tier VC fund that originally sourced the deal.
Co-investment funds can reduce fees compared to traditional fund structures
Co-investment funds typically do not charge any management fees or carry. This contrasts with the typical “2 and 20” fee structure seen in most private equity and venture capital funds, which charge a 2% management fee and 20% carried interest. By avoiding these fees through co-investing, more of the returns flow through to the investors. However, investors need to weigh the fee savings against the other pros and cons of the co-investment model.
Returns may be enhanced through co-investing compared to investing in a fund
Various studies have shown that co-investment returns can exceed the returns of merely investing in a private equity or VC fund. For example, a 2015 study by Lexington Partners found that co-investment returns exceeded main fund returns by 5% on average. This outperformance is generally attributed to the lack of fees and the potential for co-investors to cherry pick the most promising deals.
Co-investment can foster closer relationships between LPs and GPs
When investors co-invest alongside a fund manager, it brings them into closer strategic alignment and fosters stronger relationships compared to just being an LP in a fund. This closer partnership can be beneficial for both parties. Investors get more visibility into deals and potentially first looks at future co-investment opportunities from that GP. Meanwhile, GPs are incentivized to offer co-investment opportunities to their most loyal LPs.
There are also risks such as lack of diversification and liquidity issues
However, there are also downsides to the co-investment model that need to be considered. First, co-investments are inherently concentrated in single companies, lacking the diversification of a portfolio of investments. The due diligence burden is also higher compared to relying on a fund manager. Additionally, directly-held company stock often takes longer to liquidate than fund interests.
In summary, co-investment funds allow investors to invest alongside experienced private equity and VC funds in deals they couldn’t access alone. This can enhance returns through lower fees and deal selectivity. However, co-investors take on more risk from lack of diversification. When implemented selectively with trusted partners, co-investing can be an attractive way to complement a broader private equity portfolio.