Investment Strategies

Co-investments are a fantastic way for investors to invest directly alongside private equity (PE) funds. It gives them more control, transparency, and potential for higher returns.

Co-investing in PE means that you get to invest in specific deals hand-picked by the managers themselves. So, you get to see where your money is going and have a say in the investment decisions. This is different from traditional PE funds, where investors commit without knowing which companies will be acquired and managers invest based on a predetermined strategy.

With co-investing, you get to invest in individual deals of your choice, alongside the PE managers and general partners (GPs). It’s no wonder that investors like family offices are choosing to partner directly with PE managers and invest alongside them in individual deals.

With this chapter, let’s understand how the Co-Investment Strategy works.

In 2009, Airbnb raised $600,000 in a seed round led by Sequoia Capital, with the help of other co-investors. The investment not only provided funding but also gave Airbnb access to its expertise and connections, enabling further growth. This collaboration helped Airbnb establish itself as a major player in the sharing economy, showcasing the power of co-investing when the right partners and strategy are in place.

Equity co-investments involve individuals pooling their funds to invest in a company while also partnering with a private equity or venture capital firm. This allows them to potentially make a significant profit and avoid high fees charged by private equity firms.

However, these investments are typically limited to large companies with good relationships with the firm and substantial investment funds. Regular investors may not be able to participate in these deals.

In 2022, private equity co-investment capital rose to US $10.3 billion, a significant increase from US $4 billion in 2010. This trend is expected to lead to new projects and increased funding.

However, the number of private equity funds decreased from 1,129 to 597 due to cautious investment practices and the difficulty for new managers to raise funds. To address this, some private equity managers opted for co-investments, partnering with other investors to fund projects together. This allowed them to raise more money and spread out their investments, extending their lifespan.

Additionally, the difficulty of obtaining loans in 2022 led to more people turning to co-investments, as investors sought ways to pay less fees and secure more funding for their investments. New rules and higher interest rates also made borrowing more expensive for projects.

Increase in Global Co-Investment Fundraising Activity in the Past Decade

Source: EY

1. Identifying Investment Opportunities

   In the initial phase of identifying investment opportunities, investors and GPs work in concert to pinpoint potential investments that meet their mutual goals. GPs play a pivotal role in this phase by using their industry networks and traditional channels like investment bankers to gather potential deals. Additionally, co-investors add value to the process with their experiences and collaborate closely with GPs to discover promising opportunities.

2. Conducting Due Diligence

   Upon finding an attractive investment prospect, the next step is to undertake a thorough due diligence. This critical evaluation examines the target company’s financial stability, operational efficiency, market competitiveness, and growth potential. Through collective expertise, co-investors and GPs meticulously evaluate the investment to ensure it fits their criteria for risk and return.

3. Finalising the Investment

   After detailed due diligence and obtaining the necessary approvals, the process advances to the investment’s finalisation. This stage sees co-investors and GPs working together to structure the deal and complete the acquisition. Essential activities during this phase include preparing legal documents, setting up governance structures, and managing the closing and funding processes.

4. Monitoring After Investment

   Post-investment, a continuous and proactive monitoring phase begins, lasting for the investment’s duration. This phase involves tracking KPIs, participating at the board level (often through observer seats for significant co-investors), engaging with the GP and contributing strategically.

• Co-investing gives private equity firms more flexibility when it comes to investing. This means they can structure deals in a way that works best for everyone involved.
• It also helps build a better relationship between investors and private equity managers. By working together, they can be more open and honest with each other, which leads to better decisions and more transparency.
• It allows investors and managers to share the risks of investing. This makes it easier to diversify and reduces overall risk exposure.
• Co-investing gives private equity firms access to more capital. This means they can invest in more projects and not just be limited to one.
• When it comes to making investment decisions, co-investors are extra careful. They do their research and make sure they really know what they’re getting into.
• Co-investing also puts a big focus on due diligence, which means looking into the details of a deal before investing. This leads to better decisions and fewer mistakes.
• Co-investors benefit from lower fees compared to traditional investments in private equity funds. This means they can potentially make more money in the end.

There are a few different approaches you can take.

Build a portfolio with your expertise

You can try to build up your expertise and invest in projects directly. This gives you the most control, but it can be pretty challenging and requires a lot of resources.

Collaborate with an established PE firm

You can team up with an experienced private equity firm. This way, you can benefit from their expertise and resources while still having some control over the investment process.

Invest in a co-investment fund

You could invest in a co-investment fund. This is a good option if you want to have less control but still want to benefit from the expertise of a professional fund manager. Plus, it’s a great way to diversify your investments and potentially earn higher returns without paying high fees.

Define clear investment criteria

Before investing, it’s important to establish clear objectives and criteria that align with your strategic goals and risk tolerance. This helps you make better decisions and ensures consistency in your investment choices.

Negotiate favourable terms

When co-investing, it’s important to negotiate terms and structures that protect your interests and enhance potential returns. This includes getting good pricing, favourable governance rights, and co-investment rights to participate in future opportunities.

Co-investing can be tricky, and there are some common pitfalls to watch out for. Here are a few things to keep in mind:

• Choose deals carefully to avoid adverse selection. Don’t invest in every deal that comes your way, or you might end up with diluted returns. Co-investors need to be experts in the industry they’re investing in. They should focus on deals that match your investment strategy and have a good track record with the private equity firm.
• Don’t be afraid to pay fees for access to good deals. While it’s great to get a “free lunch,” sometimes you need to pay fees to get the best returns.
• Co-investments can help build relationships with private equity firms, but they can also damage relationships if investors back out at the last minute. Co-investors need to be actively involved in the investment process. They need to be transparent about their investment process and communicate clearly with the private equity firm to make the experience a positive one.
• Co-investing can be time-consuming and expensive

Remember, co-investing can be a great way to get higher returns and diversify your portfolio. Just be aware of the risks and pitfalls, and use strategies to help mitigate them. With the right approach, co-investing can be a powerful tool for investors.