[ U P D AT E ]
Private equity
managers wary
of co-investing
challenges
GROWING DEMANDS OF CO-IN-
VESTMENT AMONG LIMITED
PARTNERS IS A CAUSE FOR
CONCERN FOR PRIVATE EQUITY
MANAGERS.
C
o-investments – a process whereby allo-
cators participate alongside their private
equity managers in deals – have become
very popular, but concerns are growing
about some of these set-ups.
The increased client appetite for co-in-
vesting is unquestionable, with a report by
data provider Preqin stating 42% of limited
partners (LPs) were currently co-investing in
deals, while 12% acknowledged they would
consider it.
Equally, a study by Vistra found 73% of
investors welcomed the growth in co-invest-
ments that has taken place over the preceding
five years. Managers have on-boarded these
not so unsubtle hints from clients. In this
highly competitive environment for LP money,
managers have little option but to offer co-in-
vestment opportunities if they are to stand
any chance of raising capital. As a result, the
same survey by Preqin found 58% of manag-
ers now provided co-investment opportunities
to end customers.
By allocating money in conjunction with their
6
Global Custodian
private equity managers, investors often get
discounted fees. Speaking at the ALFI Private
Equity and Real Estate (PERE) Conference
in Luxembourg, Jerome Wittamer, president
of the Luxembourg Private Equity & Venture
Capital Association (LPEA) and founding part-
ner at Expon Capital, said management fees
on co-investment deals were typically priced
at 1% versus the 2% private equity standard,
while performance fees were around 10%
compared to the traditional 20%.
The fee benefits are not the whole story.
The chief advantage of co-investing is that
the returns tend to be better. “The return
benefits of co-investing are significant as the
transactions tend to be the prime deals. This
is evidenced by the fact that co-investments
frequently outperform fund performance,”
said Wittamer. The caveat of course is that
investors have far greater concentration risk
to the investments so while the rewards can
be more generous, the risks tend to be much
higher.
Wittamer added co-investing provided more
capital for managers to work with on deals,
although highlighted that most transactions
tended to small-to-medium sized.
Nonetheless, co-investing brings about a
number of corporate governance challeng-
es and operational issues for the industry.
“Co-investing can occasionally be a distraction
for managers as the process takes more time,
and this can sometimes endanger deals. This
may be because some LPs do not always
understand the way in which certain deals are
structured,” explained Wittamer.
A briefing by law firm MJ Hudson warned
Private Equity Issue 2018
that managers must be consistent in how
they apply expenses and charges to clients.
“The GP (general partner) should have allo-
cation policies and procedures in place and
apply them consistently to ensure that all LPs,
whether co-investing or not, do not pay more
than their fair share of expenses in the context
of any co-investment, actual or aborted,” said
the MJ Hudson document.
The MJ Hudson article also warned LPs
that identifying companies to buy and sell
was a very different proposition to acquiring
units in private equity funds. A lack of LP
understanding about co-investing therefore
exposes clients to heightened risk and losses
should deals go wrong. “Some LPs such as
state-run pension funds may face constraints
on how much they can pay staff which makes
it difficult to recruit top quality talent from
investment banks and major private equity
firms,” added the MJ Hudson report. However,
it highlighted that co-investors lacking an
experienced team could leverage external
experts to assist them with due diligence and
transaction management.
A growing trend, according to Frédérique
Lifrange, partner at law firm Elvinger Hoss
Prussen, has seen an insistence by LPs de-
manding that not every client receive the right
to co-invest on deals. “Some LPs have been
negotiating with their managers to impose a
minimum investment threshold before they
are allowed to co-invest. There is a fear that
some investors are allocating small tickets
purely so they can co-invest at a later stage,”
she said.