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Do co-investors have to take a purely passive role?
SHORT. The purest form of co-investment is often seen as
being practiced by institutional investors such as mediumsized
pension funds and insurance companies. These may
have the institutional patience and implicit confidence in their
counterparties to limit themselves to a purely passive role
behind a lead investor. By contrast, many family offices take a
more active approach while co-investing, for example including
participation in corporate governance. This may not be a
completely pure form of co-investment but this large and diverse
constituency is important and should not be ignored.
As co-investments are generally offered on a no-fee basis, can
they exhibit adverse selection?
LONG. One concern may be that lead investors will offer only
the less attractive investment opportunities to prospective
co-investors (so-called adverse selection). One way to mitigate
this risk would be to co-invest through a private-equity platform
that itself produces a significant flow of investment and
demonstrably pursues a highly selective approach with due
consideration of its own fiduciary responsibilities.
Do mid-market funds also offer opportunities?
LONG. Mid-market funds may lack the manpower and skills of
the mega funds. However they are probably most in need of
co-investment and their often under-resourced investor-relations
teams may therefore be very keen to maintain close relations
with their most active limited partners. The large numbers of
these funds, combined with their relative lack of resources and
organization, have meant that they have proved a fertile hunting
ground for the most sophisticated co-investors.
Must fundless sponsors always be ignored?
SHORT. Fundless sponsors intend to put little or no equity into
the deal into which you are being asked to invest, instead taking
a fee or other forms of compensation. Such deals are not for
the faint-hearted, but with appropriately aligned interests there
is in theory nothing to prevent a deal from a fundless sponsor
outperforming one done with a brand-name fund. This may be a
space to watch if investors become increasingly crowded out of
more traditional co-investments.
Can use of a co-investment fund make sense?
LONG. Ironically, when a private-equity platform sells a
co-investment fund, it is in fact selling you a blind-pool limited
partnership (one without any visibility on ultimate investments) – pretty much the exact opposite of a normal co-investment.
But this can make sense for an investor. In addition to mitigation
of adverse selection, with one commitment it may be possible
to achieve a degree of diversification (in terms of geography,
industry, manager, size, investment style and risk profile) that
would be impossible to achieve with a commitment to a single
manager.
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