What Is an Equity Co-Investment?
An equity co-investment is aminority investment in a company made by investors alongside a private equityfund manager or venture capital (VC) firm. Equity co-investment enables other investors to participate in potentially highly profitable investments without paying the usual high fees charged by aprivate equity fund.
Equity co-investment opportunities are typically restricted to large institutional investors who already have an existing relationshipwith the private equity fund managerand are oftennot available to smaller or retail investors.
Key Takeaways
- Equity co-investments are relatively smaller investments made in a company concurrent with larger investments by a private equity or VC fund.
- Co-investors are typically charged a reduced fee, or no fee, for the investment and receive ownership privileges equal to the percentage of their investment.
- They offer benefits to the larger funds in the form of increased capital and reduced risk while investors benefit by diversifying their portfolio and establishing relationships with senior private equity professionals.
Understanding Equity Co-Investments
According toa study by Preqin, 80% of LPs reported better performance from equity co-investments compared to traditional fund structures. In a typical co-investment fund, the investor pays a fund sponsororgeneral partner (GP) with whom the investor has a well-defined private equity partnership. The partnership agreement outlineshow the GP allocates capital anddiversifies assets. Co-investments avoid typical limited partnership(LP) and general (GP)funds by investing directly in a company.
Why Limited Partners Want More Co-Investments
In 2018, consulting firm McKinsey stated that the value of co-investment deals has more than doubled to $104 billion since 2012. The number of LPs making co-investments in PE rose from 42 percent to 55 percent in the last five years. But direct investing LPs grew by only one percent from 30 percent to 31 percent during the same period.
Why would a private equity fund manager give away a lucrative opportunity? Private equity is usually invested through anLPvehicle in a portfolio of companies. In certain situations, the LP's funds may already be fully committed to a number of companies, which means that if another prime opportunity emerges, the private equity fund manager may either have to pass up the opportunity or offer it to some investors as an equity co-investment.
According to Axial, an equity raising platform, almost 80% of LPs prefersmall to mid-market buyout strategies and $2 to $10 million per co-investment. In simple words, this means that they prefer to focus on less flashy companies with expertise in a niche area as opposed to chasing high-profile company investments. Almost 50% ofsponsors did not charge any management fee on co-investments in 2015.
Equity co-investment has accounted for a significant amount of recent growth in private equity fundraising since the financial crisis compared totraditional fund investments. Consulting firm PwC states that LPs are increasingly seeking co-investment opportunities when negotiating new fund agreements with advisers because there is greater deal selectivity and greater potential for higher returns.
Most LPspay a 2% management fee and 20% carried interest to the fund manager who is the GP while co-investors benefit from lower fees or no fees in some cases, which boosts their returns.
The Attraction ofCo-Investments for General Partners
At first glance, it would seem that GPs lose on fee income and relinquish some control of the fund through co-investments. However,GPs can avoid capital exposure limitations or diversification requirements by offering a co-investment.
For example, a $500 millionfund could select three enterprises valued at $300 million. The partnership agreement might limit fund investments to $100 million, which would mean the firms would be leveraged by $200 millionfor each company.If a new opportunity merged with an enterprise value at $350, the GP would need to seekfunding outside its fund structure because it canonly invest $100 milliondirectly. The GP couldborrow $100 million for financing and offer co-investment opportunities to existing LPs or outside parties.
The Nuances of Co-Investments
While co-investing in private equity deals has its advantages, co-investors in such deals should read the fine print before agreeing to them.
The most important aspect of such deals is the absence of fee transparency. Private equity firms do not offer much detail about the fees they charge LPs. In cases like co-investing, where they purportedly offer no-fee services to invest in large deals, there might be hidden costs. For example, they may charge monitoring fees, amounting to several million dollars, that may not be evident at first glance from LPs.
There is also the possibility that PE firms may receive payments from companies in their portfolio to promote the deals. Such deals are also risky for co-investors because they have no say in selecting or structuring the deal. Essentially, the success (or failure) of the deals rests on the acumen of private equity professionals that are in charge. In some cases, that may not always be optimal as the deal may sink.
One such example is the case of Brazilian data center company Aceco T1. Private equity firm KKR Co. acquired the company in 2014 along with co-investors, Singaporean investment firm GIC and the Teacher Retirement System of Texas. The company was found to have cooked its books since 2012 and KKR wrote down its investment in the company to zero in 2017.
FAQs
An equity co-investment is a minority investment made by an investor into a company or venture. Co-investors are typically institutional or high-net-worth investors who make their investments alongside private equity or venture capital firms.
How does equity investment work? ›
An equity investment is money that is invested in a company by purchasing shares of that company in the stock market. These shares are typically traded on a stock exchange.
What is co invest equity? ›
An equity co-investment (or co-investment) is a minority investment made by the co-investor into a company. The investment is made alongside a financial sponsor. An example of a co-investor includes institutional investors such as an insurance company, pension fund, or endowment.
What is an example of a co-investment? ›
For instance, an investor might choose to invest in the Blackstone Group, a well-known PE fund. Co-Investment: In this method, the investor invests in a fund's portfolio company. For example, an investor might co-invest in a promising start-up with a venture capital fund like Sequoia Capital.
What is the difference between private equity and co-investment? ›
Broadly, a co-investment is an investment in a specific transaction made by limited partners (LPs) of a main private equity (PE) fund alongside, but not through, such main PE fund. This is often accomplished through a separately structured co-investment vehicle which is governed by a separate set of agreements.
How do investors get their money back from equity? ›
If a company has given investors a percentage of their company through the sale of equity, the only way to reclaim the stake in the business is to repurchase shares, a process called a buy-out.
What is an example of an equity investment? ›
Shares of listed companies are the most well-known equities. Other examples include currencies, commodities, preference shares, convertible bonds or investment funds themselves.
How does co-invest work? ›
An equity co-investment is a minority investment made by an investor into a company or venture. Co-investors are typically institutional or high-net-worth investors who make their investments alongside private equity or venture capital firms.
What is the difference between equity shares and investment? ›
Equity shares yield the highest returns on total investment in the stock market. However, it has the highest amount of risks associated as well, which do not bore well with risk-averse investors. Alternative investment options in the form of debt instruments can be undertaken by them, which have lower risk burden.
What is the minimum equity for a co founder? ›
Equity allocation to co-founding team members should reflect a reward for the value they're expected to contribute. If the expected contributions are fairly equal, then the initial equity should be allocated relatively equally (for example, 51% and 49%).
A company that issues and invests in securities. The three types of investment companies are mutual funds, closed-end funds, and unit investment trusts.
What is the difference between investor and co owner? ›
An investor will basically put money in the business in hopes getting some returns on his/her investment. On the other hand, business partners co-own a business. They raise the capital for the business as per agreement with each other.
Is private equity a fund? ›
What are Private Equity Funds? Private equity funds are pools of capital to be invested in companies that represent an opportunity for a high rate of return. They come with a fixed investment horizon, typically ranging from four to seven years, at which point the PE firm hopes to profitably exit the investment.
What are the fees for co investing? ›
Typically the economics of a traditional fund include a 2.0% management fee and 20% sharing of profit, known as carried interest. Providers offer co-investment funds at significantly lower fees—for example, a 0.75%-1.50% management fee and 10%-15% carried interest.
Is it better to work in private equity or investment banking? ›
So, if you're interested in finance and deal-making, investment banking is the way to go. If you're more interested in strategy and operations, private equity might be a better fit.
Is private equity the best investment? ›
Private equity is an attractive investment option for high-net-worth individuals and institutional investors because of its potential for high returns. Private equity falls under the category of alternative asset classes.
How do beginners invest in equity? ›
How can I begin investing in equities? You can open a demat account with a broker firm to invest in the stock market. Or you can approach a financial advisor who will guide you on what to buy, and then purchase the funds for you. Another option is to equity funds from a fund house directly.
Are equity funds a good investment? ›
Equity funds provide investors with several benefits, including diversification, professional management, and the potential for superior returns. These funds also come with risks associated with stock market volatility and losses.
How do equity method investments work? ›
The equity method is typically applied when a company's ownership interest in another company is valued at 20%–50% of the stock in the investee. The equity method requires the investing company to record the investee's profits or losses in proportion to the percentage of ownership.
What is a disadvantage of equity financing? ›
Equity Financing also has some disadvantages as compared to other methods of raising capital, including: The company gives up a portion of ownership. Leaders may be forced to consult with investors when making a decision. Equity typically costs more than debt financing due to higher risk.
