Co-Investment Rights
Definition
Co-investment rights are the terms under which a private fund's investors may invest additional capital directly in a portfolio company or asset alongside the fund, in the same security at the same time and price, outside the fund's commitment. The manager offers a co-investment when a deal is larger than the fund's concentration limit allows or than the manager wants to hold alone; the investor takes it through a separate co-investment vehicle the manager controls, typically paying no management fee and no carried interest, or reduced ones. The right is usually a right to be offered, not a right to receive: the limited partnership agreement or a side letter says the manager will consider the investor for co-investments, the manager allocates at its discretion, and the largest, fastest and most relationship-valuable investors are offered the most. For the investor the attraction is exposure to the manager's deals at near-zero fees; the risks are concentration, adverse selection, and having to decide in days on a deal the fund spent months on.
Why it matters
Co-investment is the largest fee saving available in private markets and the most unevenly distributed. An institution that puts a third of its private equity program into fee-free co-investments alongside its fund commitments lowers its blended cost by nearly a point a year; an individual investing through a feeder pays two fee layers on the fund and sees no co-investment at all, or pays a platform for one. The rights also decide something about the fund itself: a manager that syndicates a lot of co-investment is running a larger effective fund than the one investors committed to, with concentration and alignment consequences the fund's own terms do not describe.
Common misconceptions
- •A co-investment right is not an entitlement. Nearly every document gives the manager discretion over whether, to whom and how much to offer; the investor's right is to be considered.
- •Fee-free is not cost-free. Co-investors bear deal expenses, broken-deal costs in some documents, and the cost of their own diligence; and the vehicle's administration is charged to it.
- •Same deal is not same return. A co-investor is concentrated in one company; the fund holds it inside a portfolio. The fund's blended return and the co-investment's return can differ widely.
- •Retail co-invest is not institutional co-invest. A platform vehicle pays the platform's fees and receives whatever allocation the platform negotiated, which is not the no-fee, first-call allocation an anchor investor receives.
Technical details
Worked example: the fee saving and the concentration
An investor commits $10 million to the $100 million fund used across this cluster (2 percent fee, 20 percent carry over an 8 percent pref) and takes $5 million of co-investment across three deals at no fee and no carry.
Fund portion: at a 2.0x gross multiple, net to the investor after fees and carry roughly 1.7x, or $17 million on $10 million.
Co-investment portion: at the same 2.0x gross, net 2.0x less deal expenses, about $9.8 million on $5 million.
Blended: $26.8 million on $15 million, 1.79x, against 1.7x had the whole $15 million gone into the fund. The saving is about $1.3 million, or 9 percent of the profit.
The cost: one of the three co-investments returns 0.5x. The investor's co-investment portion now returns about $7.3 million, blended 1.62x, below the fund alone. Three deals do not diversify; the fund's twelve do.
How the right is written
LPA language: the general partner may offer co-investment opportunities to limited partners and others in its discretion; no partner has a right to any allocation; the GP may charge fees and carry on co-investments.
Side letter language: the investor will be offered co-investment opportunities on a priority, pro rata or best-efforts basis, sometimes with a target allocation or a minimum notice period; MFN clauses spread the better versions to other electing investors of similar size.
Allocation policy: many managers now publish one, describing how opportunities are allocated among the fund, co-investors, other managed accounts and affiliates; SEC examinations have focused on whether managers follow their own policies.
Vehicle terms: a co-investment LP or LLC per deal, with the manager as GP, minimal fees, expenses borne by the vehicle, transfer and exit tied to the fund's.
Why managers offer it
Deal size: to buy a company larger than the fund's concentration limit permits without bringing in a competitor.
Fundraising: to reward anchor investors and to court prospects for the next fund; co-investment access has become a standard ask in fundraising.
Fee pressure: to give large investors a lower blended fee without cutting the headline fund terms.
Control: syndicating to passive co-investors keeps governance of the company with the manager, which a co-sponsor would not.
What the co-investor should check
Alignment of terms: same security, same price, same exit as the fund; no fund-level fees charged twice; who pays broken-deal costs.
Why the deal is being syndicated: fund limit, size or something else; how much of the manager's other funds and its own capital are in it.
Allocation: how much the manager offered, to whom, and whether the investor's share is pro rata to its commitment or something less.
Governance: what rights the co-investment vehicle has if the fund and co-investors disagree about an exit; usually none.
Concentration: the co-investment as a share of the investor's private markets program; institutional policies typically cap single-deal co-investments at 1 to 2 percent of the program.
Co-investment in retail-facing structures
Access funds and feeders: the feeder is one investor in the master fund and rarely receives co-investment; where it does, the platform decides whether to pass it on and at what fee.
Platform co-investment vehicles: single-deal or multi-deal pools built from allocations the platform negotiated with managers; the investor pays the platform's fee and carry and gets the platform's diligence.
Deal-by-deal syndication platforms: SPVs that raise from individuals for a specific company; structurally co-investment, but usually sourced from the SPV sponsor's own network rather than a fund's allocation.
Reg A and crowdfunding: not co-investment; the issuer sells directly to the public without a fund alongside.
Frequently asked questions
- What is a co-investment in private equity?
- A direct investment by a fund's investor in one of the fund's deals, alongside the fund, in addition to the investor's commitment. If a fund with a $50 million single-deal limit buys a company that needs $80 million of equity, the manager offers the extra $30 million to its investors as co-investment. They invest through a vehicle the manager sets up for that deal, hold the same securities as the fund, and exit when the fund exits.
- Do co-investments charge fees and carry?
- Often not, which is the point. The market convention for institutional co-investment is no management fee and no carry, or a reduced set such as 0.5 percent and 10 percent, because the investor is helping the manager complete a deal and the manager already earns fees on the fund's portion. Co-investment funds and platform vehicles that pool smaller investors' money do charge their own fees, commonly 1 percent and 10 percent, on top of any the manager charges.
- Who gets co-investment allocations?
- The investors the manager most wants to keep: the largest commitments, the ones who have negotiated co-investment priority in side letters, the ones who can commit within days and have done so before, and the ones the manager is courting for its next fund. Allocation is at the manager's discretion in almost every document; a right to be offered pro rata is rare and a right to receive is rarer. Small investors and feeder-fund investors generally see none.
- What is the adverse selection risk in co-investing?
- That the deals offered are the ones the manager could not or did not want to hold in full. Co-investments cluster in the largest deals, which are the most competitive and most expensive, and a manager may syndicate the deals it is least confident in while keeping the rest. Academic studies of co-investment returns have found them roughly in line with or below the funds that offered them once concentration is accounted for; the fee saving is real, the selection effect works against it.
- How much time do investors get to decide?
- Days to a few weeks. The fund has done the diligence; the co-investor gets the fund's investment memorandum, a data room and a deadline set by the deal's signing or closing. Investors that co-invest well have staff and process to underwrite a deal in that window; investors that do not tend to rely on the manager's work, which is the point at which co-investing becomes a fee-free extension of the fund with none of the fund's diversification.
- What is a platform co-investment vehicle?
- A pooled vehicle run by a wealth platform or fund of funds that takes co-investment allocations from managers and sells slices to its own investors, at minimums of $100,000 or so. It converts an institutional right into a retail product and charges for doing so; the investor gets the manager's deal at the platform's fee, often 1 to 1.5 percent plus 10 percent carry, in a single-deal or multi-deal vehicle. The allocation the platform received, and why, is worth asking about.