Behind The Co-Investment Curtain: Current 'Market' Terms Revealed

Author:Mr Mark Silveira
Profession:MJ Hudson
 
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Co-investments are now an integral part of the private equity funds market, popular with GPs and LPs alike. In a classic co-investment, an investor is invited by a GP to make a separate, additional investment in a target company (the Target) alongside the main investment being made by the GP's fund (the Sponsor Fund). Co-investors may acquire the Target's shares directly, or their exposure to the Target may be indirect, through a co-investment vehicle (the CIV) run by the Sponsor Fund's GP. The CIV may be dedicated to just the one deal, or it may be a standing vehicle making multiple co-investments.

Although CIVs resemble mini-funds (indeed, they are often structured as limited partnerships, with the Sponsor Fund GP serving as general partner), they are heavily customised for the co-investors and investment(s) in question, and differ from conventional blind pool funds in several aspects:

Management fees

GPs use co-investment opportunities as a way to cement and grow the relationship with key LPs in their existing funds. That's one reason why management fees on co-investments are kept comparatively low - typically 0.5% to 1% of committed capital, invested capital or net invested capital, per year, as against the 1.5% to 2% seen in conventional blind pool funds. Some CIVs are fee-free, or only charge fees to co-investors who are not LPs in the Sponsor Fund.

Target fees

Even in a zero-fee vehicle, the GP may be able to take (without an accompanying offset obligation) one-off transaction and annual monitoring fees from the Target directly, which together comprise a de facto management fee. Co-investors (particularly if they are LPs in the Sponsor Fund, which can be expected to have its own complete or partial fee offset) typically negotiate to prohibit Target-level fees or, if they are commercially justified, to fix or cap them.

Carry

Like fees, CIV carried interest is invariably lower than in blind pool funds. We usually see co-investment carry in the 5% to 15% range. Ratcheted carry is increasingly popular: the carry rate moves up or down in line with total cash returns to co-investors. If the GP earns substantial fees from the CIV, then there may be zero carry. If co-investors pay carry, then they will benefit from a hurdle - generally, 6% to 8%.

Expenses

Transaction-related expenses (with the possible exception of abort costs; see below) are apportioned between the Sponsor Fund and the co-investors in line with their investments in the...

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