The Co-Investment Process – How to Capture the Opportunity and Avoid the Pitfalls

Post the Global Financial Crisis, LPs have spent significantly more time focused on averaging down their fees and upsizing their performance. One of the most obvious ways in which they have been trying to accomplish both is by deploying capital through co-investments. Unfortunately, some GPs mishandle the co-investment syndication process and some do not put in sufficient thought into identifying the most suitable co-investment partner — especially as it relates to their broader fundraising strategy. In a moment, I will identify some of the critical steps to take when managing a co-investment syndication process. As many GPs know, co-investment opportunities can be a powerful inducement to building long term LP relationships. However, if these opportunities are mishandled a GP can extinguish an LP’s interest in the manager permanently. Another major advantages of a well-run process, is a GPs ability to also secure fees and/or carry on the investment and there are various structures and means to doing so. We will explore this process as well.

As we think about co-investments let’s focus on two scenarios that we see most commonly in the market:

Scenario 1: Sometimes it is better to go for the paper-clip, not the staple:

Whether GPs are between funds, have an undersized fund (relative to their investment deal flow) or are simply operating without a fund at all — they can frequently focus too heavily on looking for stapled capital when offering out co-investments to prospective investors. What is often lost in this process is the fact that LPs are treating this interaction as a dress rehearsal for being a primary investor and are scrutinizing each exchange. LPs are assessing the strength of the GP’s sourcing channels, how disciplined the GP has been in screening the opportunity, and the quality of the due diligence that they perform. LPs are also paying particular attention how the GP communicates with the LP and behaves as a partner. The GP should likewise be determining how engaged the LP is and how cumbersome its process is during this exchange. Where an LP can validate the quality of the GP and co-investment opportunity (and process), we have seen them ultimately commit to a GP with whom they have built a relationship during this process – even if, they initially passed on the co-investment itself.  In those circumstances where an LP doesn’t staple into a fund, GPs are increasingly able to negotiate monitoring, transaction and carry with the LP. Transaction fees can work as a percentage of equity or enterprise value, monitoring fees will typically be capped and carry can step all the way up to a full 20% with proper hurdles. Sixpoint has deep experience raising capital for fee-based co-investment transactions and negotiating these fee structures. We would be pleased to discuss your co-invest needs or provide input and advice that may be instructive to your thinking.

Scenario 2: Co-Investment is not always the primary answer:

When GPs are in fundraising mode, it is less common to see LPs pay full fees, if any fees at all, but it is not unprecedented. Regardless, the focus of these interactions should be less on economics and much more on impressing the LPs with high-quality and timely communication. We increasingly see new entrants into the co-investment space including some noteworthy consultants. The level of due diligence and the speed in which LPs are able to respond to these expansive requests are key determinants for moving forward with these types of groups. There are many cases where quality GPs have lost sizable primary commitments because they weren’t properly prepared for the intensity of the interactions and they couldn’t turn the requests on the primary raise in the timeframe required to secure the commitment.

We frequently see GPs focus all of their efforts on getting an LP’s co-investment team up-to-speed on the specifics of the transaction in question while forgetting that a primary commitment typically requires the engagement of other members of the LP’s investment team. It is critical that both teams are working in parallel during this narrow window of time if the commitments are to happen simultaneously. GPs should request that they have access to the proper audience during this process to ensure the best possible results. Sixpoint Partners understands the nuanced relationship between the co-investment and primary teams at key LPs and has access to multiple points of contact at all levels. We can help you navigate the complicated nature of these relationships to secure both co-investment and primary capital for your next fundraise.

Next on 60 Seconds with Sixpoint: Process vs Placement, do you need a Placement Agent? Building a long-term relationship with the market.

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