The Investment Strategy That’s Reshaping Private Equity

In non-public fairness, the neatest common companions (GPs) are realizing that co-investments aren’t only a fundraising sweetener; they are a strategic lever. Finished proper, they strengthen the portfolio, deepen LP relationships and scale back total threat publicity. But many GPs nonetheless deal with co-investing as an afterthought relatively than a core aspect of fund technique.

In at present’s local weather, the place LPs are extra selective, underwriting requirements are greater and belief is tougher to earn, co-investments might be the sting that separates high-performing GPs from the pack. This is how essentially the most subtle companies are utilizing co-investing not simply to boost capital, however to construct resilient portfolios and tighter LP alignment.

Associated: The Collaboration Between Limited Partners and Growth Partners: Investors’ Perspective

Why co-investments matter greater than ever

The co-investment market has matured quickly over the previous decade. In response to Preqin’s Global Private Equity Report, almost 70% of LPs now anticipate co-investment alternatives from their fund managers. This demand is now not restricted to mega-institutional household places of work. Sovereign wealth funds and even smaller foundations are searching for methods to extend publicity to direct offers whereas reducing blended price buildings.

In the meantime, a 2023 report from PitchBook emphasised that co-investment quantity is rising even in risky markets, fueled by LPs in search of extra management, decrease charges and deeper entry to high quality offers.

For GPs, this presents each a problem and a possibility. The problem: Co-investments can pressure inner sources and sluggish deal execution if not managed properly. The chance: When constructed into the fund’s operations and technique from day one, co-investments improve portfolio flexibility, entice strategic LPs and scale back focus threat, all with out diluting fund governance.

Co-investing as a instrument for portfolio development

Sensible GPs deal with co-investment capability as a part of their capital stack, not a separate, advert hoc providing. This mindset permits them to:

• Pursue bigger offers than the fund alone may help, with out rising fund-level focus.

• Add diversification by allocating fund capital to core positions and alluring co-investors into adjoining or higher-risk belongings.

• Act shortly on opportunistic offers by pre-qualifying LPs who can co-invest with brief discover.

As an example your $100M fund is concentrating on 10 core platform offers of $10M every. You come throughout a $25M acquisition that matches the thesis however exceeds your single-asset publicity cap. With co-investment capital lined up, you’ll be able to nonetheless lead the deal, funding $10M from the fund and $15M from co-investors. This method maintains portfolio steadiness whereas giving LPs direct entry to a bigger asset.

Extra importantly, it builds your repute as a GP who brings entry, not simply capital.

For a case examine of this dynamic in motion, this piece from Hamilton Lane illustrates how co-investments have develop into an important instrument in trendy non-public market technique.

Associated: The Risks And Rewards Of Direct Investment For LPs

Decreasing threat whereas rising possession

One underappreciated good thing about co-investing is the way it permits GPs to retain management of high-conviction belongings with out overexposing the core fund. In lots of instances, essentially the most enticing offers are additionally essentially the most capital-intensive. With out co-investment companions, a GP should select between taking a smaller slice or over-allocating from the fund.

By bringing in co-investors, GPs can safe majority or lead positions whereas staying inside prudent limits. This improves management over governance, exit timing and worth creation plans, all essential levers in lowering draw back threat.

Moreover, co-investing is usually a highly effective instrument in navigating market cycles. Throughout downturns, GPs can selectively syndicate capital-heavy offers to protect dry powder, whereas nonetheless deploying into discounted alternatives. The BVCA’s 2023 Private Equity Guide gives insights into how companies are adjusting their co-investment conduct throughout a recession.

The operational spine of a co-investment technique

In fact, providing co-investments is not nearly having the deal circulation. The GPs who excel at this have constructed inner programs to deal with:

• Authorized structuring: Fast SPV setups, allocation mechanics and clear governance roles

• LP segmentation: Understanding which traders have the urge for food, capability and decision-making velocity to co-invest

• Information sharing: Safe, real-time entry to diligence supplies and post-investment reporting

• Compliance and equity: Guaranteeing clear allocation that does not drawback the core fund

This operational spine is commonly the distinction between companies that “can” provide co-investments and those who achieve this constantly, cleanly and at scale.

For GPs trying to mature their fund ops, platforms like Carta and Juniper Sq. simplify co-investment administration, LP communications and investor onboarding.

Extra superior GPs are additionally utilizing instruments like Passthrough to streamline subscription paperwork or Anduin for automated investor workflows.

Co-investment fosters lasting belief

From an LP viewpoint, we see co-investing as a technique to show confidence and alignment. It provides them extra say, extra return and sometimes a bigger position on the desk. When accomplished pretty, it turns your traders into what they’re — full companions. In a world that’s changing into extra relationship-based by way of fundraising, GPs who put in constant, considerate co-investments are better off.

• Retain high LPs in future funds.

• Convert one-time traders into anchor commitments.

• Win allocations in aggressive fundraising cycles.

In response to HarbourVest’s 2023 LP Survey, almost 80% of LPs reported greater satisfaction and belief in managers who provided co-investment entry, particularly when the offers carried out properly and have been communicated transparently.

Associated: Why Direct Investments By LPs Are On the Rise

A phrase of warning: Do not over-promise

With all its benefits, co-investing just isn’t a silver bullet. When used excessively or poorly, it might convey execution threat, create inefficiencies and convey LPs into battle. The commonest shortcomings are:

• Offering an excessive amount of in co-investments, devaluing their high quality

• Granting favors with allocations

• Procrastinating closings from aspect deal logistics

• Failing to coordinate inner bandwidth to deal with the complexity

The very best companies are selective. They set expectations with LPs early, usually within the PPM or DDQ, and give attention to high quality over amount. One wonderful co-investment that delivers a win might be extra highly effective than 5 rushed ones that do not carry out.

Co-investments are now not elective; they are a defining function of recent non-public fairness. However the edge would not come from providing them. It comes from integrating them into your portfolio development, risk management and LP technique.

The neatest GPs know this. They use co-investing not simply to fill out a cap desk, however to construct sturdy LP relationships, de-risk massive bets and unlock operational agility. As fundraising turns into extra aggressive and LPs demand extra from their managers, those that deal with co-investing as a core fund ops functionality, not a last-minute provide, will stand out.