Co-investments in private equity are becoming increasingly popular as they offer investors more transparency and often higher return potential.
Benefits of Co-Investments
- Risk Reduction: Co-investments allow investors to participate in well-vetted deals and minimize loss risk through increased involvement in decision-making.
- Better Returns: Limited Partners (LPs) gain access to high-yield individual investments and can avoid fund-level fees, potentially leading to higher net returns.
- Diversification: Co-investments help LPs broaden their portfolio and access various markets and sectors, optimizing risk distribution.
- Tax Optimization: With better insights into tax implications, co-investors can plan taxes more efficiently.
But What Are Co-Investments?
Co-investments are direct investments made jointly by multiple parties into a specific project or company. In a co-investment, an investor (the limited partner or LP) — usually an institutional investor or family office — invests alongside a main investor (e.g., a private equity firm, or general partner, GP) in an investment. Co-investors typically hold a minority stake, while the main investor retains the majority and often manages the investment.
The advantage for co-investors lies in gaining access to large and often exclusive projects while keeping administrative and management costs low. Since the GP conducts most of the due diligence, co-investors have better insight into the quality of the investment and can better assess specific risks.
GPs are also responsible for deal sourcing, finding attractive investment opportunities, and bringing LPs on board. Often, these deals require additional capital, which means a good relationship between GPs and LPs is necessary to close this funding gap. GPs invest considerable time and resources into identifying attractive deals and maintaining necessary relationships.
A key component of successful co-investments is the clear definition of the partnership structure. This includes terms for capital returns and profit distribution, such as in a buyout or IPO.
Rising Demand for Co-Investments
Between 2010 and 2022, capital raised for co-investments increased from USD 4 billion to over USD 10 billion annually, according to Pitchbook, a leading provider of data and research in global capital markets, with a peak in 2021 at over USD 16 billion. In terms of transaction volume, the market has stabilized at around USD 30 billion in recent years, according to private market asset manager Stepstone. There was a surge to over USD 60 billion in 2021 as trillions of USD and EUR in fiscal incentives aimed to stimulate the global economy, and zero-percent interest rates pushed M&A activity and associated co-investments to record levels. Together, these figures highlight the strong demand and attractiveness of this form of investment.
Risks and Challenges
As with everything in life, co-investments also come with challenges, not just advantages. Many co-investors rely on the due diligence of the private equity fund, which can make it challenging to gain one’s own informed insights, especially with deals that need to close under time pressure. This haste leaves LPs with little time for their own reviews, leading to potential risks. Additionally, co-investments require specialized knowledge to identify opportunities and actively manage investments. Investors without in-house expertise may struggle to compete for lucrative deals.
Another factor is the increasing competition among investors for co-investment opportunities, as more investors enter this market. This competition amplifies the need for GPs to maintain relationships with experienced LPs and position themselves as reliable partners.
Investment Opportunities for Private Investors
While the co-investment market has previously been accessible only to institutional or very wealthy private investors, new structures are opening opportunities for other investors. On the one hand, more family offices are participating in tailored co-investment opportunities. Even the “ordinary” private investor now has access to this attractive form of investment through ELTIFs specializing in co-investments.