What it means
In a typical private equity fund, investors called limited partners (LPs) hand money to a manager, who chooses the deals. The manager charges an annual management fee and keeps a share of profits, known as carried interest or carry.
When a deal is too large for the fund to fund alone, the manager may invite selected LPs to invest directly in that deal as well. For the manager, co-investment fills the funding gap without needing a larger fund, and it rewards loyal investors.
For the LP, it can lower the average fee paid on its total private equity exposure. Terms vary, but co-investments often carry reduced fees or no fees and little or no carry.
The trade-off is that the LP has to do more work. It receives less time to review the deal, may need its own team to assess risks, and does not get the diversification of a whole fund.
A single co-investment is a concentrated bet, so one poor outcome has a bigger effect on returns. Co-investment also changes the relationship between manager and investor.
LPs that can write large cheques quickly are valued, and they may get offered the best opportunities. Managers should treat co-investors fairly and disclose how deals are allocated, because conflicts of interest can arise when one party gets better terms.
A common variant is the sidecar vehicle, a separate entity set up to hold co-investments from several LPs under one set of terms. Another is the syndicated deal, where the manager sells down part of a stake to others after closing.
Either way, the legal documents should state fees, rights to information and exit timing clearly. Documentation deserves attention as well.
Co-investors normally sign a short agreement setting out how the deal will be managed, who makes decisions and how the exit will be shared. A clear agreement avoids disputes if the fund manager and the co-investor disagree about timing the sale.
In practice
Real-world examples.
Example
A university endowment commits $25,000,000 to a buyout fund and is later offered a further $5,000,000 to invest directly in a healthcare acquisition. It accepts, paying no fee on the extra amount. Its blended fee across the whole programme falls, because part of the money now carries no charge at all.
Example
A family office is invited to co-invest in a logistics company alongside a growth equity fund. It has only three weeks to decide. The team declines because it cannot complete adequate due diligence in time, and it records that discipline as a strength rather than a missed chance.
Example
A sovereign wealth fund creates a sidecar vehicle with a technology fund manager. The sidecar invests alongside the main fund in each deal above $50,000,000. The fund manager gains access to extra capital without raising a larger fund.
Formula
Calculation
Fees saved = (Investment x Management fee rate x Years held) + (Gain x Carry rate)
Worked example: A pension fund invests $10,000,000 directly in a deal alongside a private equity fund, with no fee or carry on that amount. Through the main fund, the same money would have paid a 2% annual management fee and 20% carry. The deal is held for 5 years and produces a gain of $5,000,000.
Management fee avoided = $10,000,000 x 2% x 5 = $1,000,000
Carry avoided = $5,000,000 x 20% = $1,000,000
Total fees saved = $1,000,000 + $1,000,000 = $2,000,000
The saving is about 40% of the $5,000,000 gain, which shows why investors value these opportunities.Case study
Seen in the real world.
Redstone Partners is an illustrative, fictional private equity firm that was buying a $120,000,000 manufacturing business. Its main fund could safely commit only $80,000,000 to a single company, which left a $40,000,000 gap.
The firm offered $40,000,000 of co-investment to four of its largest investors. Each received a slice with no management fee and a reduced carry, in return for committing quickly. All four accepted, and the deal closed on schedule.
In this illustrative story, the investors enjoyed lower costs, and Redstone avoided losing the deal. Two years later, one co-investor reported that the deal had done well, but another noted that the lack of diversification would have hurt badly if it had gone the other way.
Watch out
Common mistakes.
- Assuming co-investments are always free of fees, when terms differ between managers and may include reduced fees or reduced carry.
- Treating a co-investment as low risk because the fund manager is involved, when the single-deal exposure is concentrated.
- Skipping independent due diligence because the manager did the work, when the manager's interests may differ from the co-investor's.
Questions
People also ask.
Who is offered co-investment rights?
Managers usually offer them to large or strategic LPs who can decide quickly and who have supported earlier funds.
Why do managers offer co-investments?
They help fund deals that are too big for a single fund and strengthen relationships with important investors.
Is a co-investment the same as a direct investment?
Not quite, because a co-investment is made alongside a manager who leads the deal, whereas a direct investment may be led entirely by the investor.
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