What is private equity co-investing?


## **Introduction** 

In addition to gaining access to private equity funds, certain investors are increasingly forming partnerships with general partners (GPs) to directly invest alongside them in specific deals.

Private equity co-investments offer investors the opportunity to support individual deals alongside fund managers, rather than investing in long-term blind pool private equity funds.

![Visual representation of the structure of an equity co-investment](https://hedonova.b-cdn.net/Hedonova%20images/%20All%20Hedonova%20blogs/What%20is%20private%20equity%20co-investing/structure-of-an-equity-co-investment.webp)

The rise in co-investments has opened up new avenues for investors to shape their private portfolios and expand their exposure to this asset class. Investors can access co-investment opportunities through various means, providing greater flexibility in constructing their portfolios. Existing investors in private equity funds are offered individual co-investments to further invest in specific deals. Additionally, there are specialized closed-ended co-investment funds available for investment, which operate alongside renowned fund managers with proven track records.

## **Co-investing in turbulent times** 

In recent years, co-investments have experienced a surge in popularity as fund managers seek fresh sources of capital and investors aim to reduce the fees they incur. Pitchbook data reveals that the total capital raised for co-investments with private equity (PE) investment managers has risen from $4 billion in 2010 to $10.3 billion in 2022.Experts even predict that co-investments may thrive in the current "more depressed" fundraising environment.

![Chart displaying global co-investment fundraising activity's past decade growth](https://hedonova.b-cdn.net/Hedonova%20images/%20All%20Hedonova%20blogs/What%20is%20private%20equity%20co-investing/increase-in-global-co-investment-fundraising-activity-in-the-past-decade.webp)

During 2022, the number of private equity funds significantly declined from 1,129 to 597. This shift occurred as limited partners (LPs) became more cautious about their investments and focused on established managers. Consequently, newly established managers faced considerable challenges, with fundraising for first-time private equity funds hitting a nine-year low. To bridge the equity gap, general partners (GPs) turned to the co-investment market. This strategy allowed PE managers to dedicate more time to raise subsequent commingled funds. Furthermore, some GPs utilized co-investments to diversify their portfolios and extend their investment period, enabling them to stay out of the market for longer periods.

In addition, debt became scarcer in 2022, further driving the demand for co-investments. This demand stemmed from LPs seeking reduced fees and a higher proportion of equity financing, as well as the increased cost of debt for buyouts due to a more stringent credit market and higher interest rates.

Overall, co-investing has emerged as a viable strategy in turbulent times, as it addresses the need for capital, provides LPs with cost-saving advantages, and allows GPs to navigate challenging market conditions while diversifying their portfolios.

## **Understanding equity co-investment** 

It is essential to clarify that equity co-investment involves investors investing alongside a private equity firm, rather than through the private equity fund. This distinguishes it from the conventional approach where institutional investors invest directly in the operating company through the main private equity fund, granting the private equity firm the authority to make investment decisions on their behalf.

In the traditional model, the private equity firm retains control over the portfolio company holdings throughout the investment lifespan, and institutional investors are obliged to participate in each investment made. In contrast, equity co-investment follows a different path. Co-investors directly invest in a single operating company.

To facilitate the co-investment process, a separate set of agreements is structured. Institutional investors interested in co-investment opportunities will submit an agreement or letter of interest to the private equity firm. The decision to offer co-investment opportunities rests with the private equity firm, although they are not obligated to do so.

In essence, equity co-investment provides investors with a distinct avenue to participate in specific operating companies alongside a private equity firm. This approach allows investors to have direct exposure to individual investments and offers flexibility outside the traditional fund structure. By engaging in co-investment opportunities, investors can potentially access unique investment prospects and tailor their investment strategies to their preferences and risk appetites. It is important for investors to carefully evaluate and negotiate the terms and conditions of co-investment agreements to ensure alignment of interests and mitigate potential risks.

## **Advantages of equity co-investment** 

Equity co-investments offer several advantages that make them attractive to both co-investors and private equity firms:

**Increased flexibility:** Co-investments provide private equity firms with greater flexibility in deploying capital. By sharing the investment with co-investors, private equity firms can have more capital available to invest in other profitable projects rather than being tied to a single transaction.

**Strengthened investor relationships and risk sharing:** Co-investments enhance the relationship between private equity firms and investors. By offering co-investment opportunities, private equity firms demonstrate a commitment to aligning interests and sharing the investment risk with co-investors. This can strengthen the overall partnership and trust between the parties involved.

**Access to more information and due diligence:** Co-investors can benefit from exposure to additional information and access to due diligence or materials that they might not have otherwise obtained. This deeper level of insight can enable co-investors to make more informed investment decisions and adjust their broader portfolio to align with their specific investment needs.

**Favorable fee arrangements:** Co-investment vehicles often come with better fee arrangements for institutional investors compared to investing in the main private equity fund. Private equity firms may reduce fees or offer more favorable fee structures to attract institutional investors. This can result in cost savings and potentially enhance the overall returns for co-investors.

The growing interest from institutional investors in co-investment opportunities highlights the appeal of these advantages. Institutional investors recognize the potential benefits of participating in co-investments, including the improved flexibility, strengthened relationships, access to valuable information, and potentially better fee arrangements.

Ultimately, equity co-investments provide a win-win situation for both co-investors and private equity firms, allowing them to leverage each other's strengths and pursue mutually beneficial investment opportunities.

## **How co-investment works**

Co-investments provide investors with the chance to make smaller investments in individual companies alongside private equity managers. Private equity firms carefully select these investment opportunities and invite co-investors to participate. This gives co-investors the ability to see exactly where their money will be invested and decide whether to join the deal or not. It's different from traditional private equity funds, which operate on a 10-year timeline and raise money without disclosing which companies will be acquired during that period. Co-investing offers transparency and gives investors more control over their investment decisions compared to traditional fund structures.

## **Challenges of co-investment**

**Limited deal flow and access:** Co-investment opportunities may be limited, particularly for individual investors. Private equity firms often prioritize their existing relationships and institutional investors when offering co-investment opportunities. This can result in a lack of access to attractive deals for individual investors.

**Concentration risk:** Co-investing can lead to a higher concentration of investments in a few companies or industries. If an investors portfolio becomes heavily dependent on a few investments, it raises the risk due to a lack of diversification. Any adverse outcomes or downturns in these investments can significantly impact the overall performance of the portfolio.

**Due diligence complexity:** Conducting thorough due diligence on individual co-investment opportunities can be complex and time-consuming. Co-investors need to assess the potential risks and growth potential of each investment carefully.

**Potential for deal dilution:** Co-investment can introduce the risk of dilution for co-investors, particularly if additional rounds of funding are required for the portfolio company. This can occur when the private equity firm seeks further capital from other investors, potentially impacting the overall ownership stakes and control of co-investors. Moreover, conflicts can arise within the fund structure if the interests of co-investors and major fund investors diverge, leading to potential tensions and disputes.

**Potential conflicts of interest and preferential treatment:** One of the concerns associated with co-investment is the potential for conflicts of interest. Private equity firms may allocate co-investment opportunities disproportionately to potential future fund investors, creating preferential treatment and an unfair advantage. This can raise questions about the alignment of interests between co-investors and the private equity firm. It is crucial for co-investors to carefully assess the distribution and allocation of investment opportunities to ensure fairness and avoid conflicts of interest.

It is crucial for investors considering co-investment to thoroughly evaluate the potential pitfalls and challenges alongside the benefits.

## **Conclusion** 

Private equity co-investing provides individual investors with a pathway to access lucrative investment opportunities, diversify their portfolios, and potentially achieve enhanced returns. By investing alongside established private equity firms, co-investors can benefit from their expertise, alignment of interests, and the potential for active involvement in portfolio companies. However, co-investing also poses challenges, such as limited deal flow and concentration risk.


Private equity co-investments offer investors the opportunity to invest directly alongside fund managers in specific deals, diversifying their portfolios and gaining exposure to lucrative investment opportunities. The rise in co-investments has opened new avenues for investors to shape their private portfolios. During turbulent times, co-investments have experienced increased popularity, addressing the need for capital, providing cost-saving advantages, and helping general partners (GPs) navigate challenging market conditions. Co-investors benefit from increased flexibility, strengthened relationships, and access to valuable information, while private equity firms gain more capital deployment options and trust from investors. Despite the advantages, challenges like limited deal flow, concentration risk, and potential conflicts of interest must be carefully evaluated by investors considering co-investment opportunities.

What is private equity co-investing?

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