In a challenging fundraising environment, co-investment is a strong bargaining chip for LPs — but it can create headaches for fund managers. In the past half decade, co-investment in private credit has gone from an occasionally utilized way of boosting fund investment capabilities to becoming a mainstay of fundraising. “For some LPs, co-investments offer a way to reduce the overall fee burden, with co-investment arrangements typically having lower or even no fees and carry,” says Ajay Pathak, a partner in Goodwin’s Private Equity practice. “Another driver is a desire by LPs to find ways to allocate more money with managers they have diligence, beyond their contribution to the main fund.” The more difficult fundraising environment and the expectation among LPs that co-investments should be offered mean they’ve now become a standard part of the fundraising process that GPs are looking to turn to their advantage. “We see more GPs thinking about co-investment allocation as a core part of their fundraising strategy today,” Pathak says. “Offering co-investment rights can entice investors to commit to a first close and help build momentum with other investors to back the strategy. Co-investment can also enable managers to pursue larger deals that they might not have been able to otherwise undertake due to fund concentration limits.”
One of the costs to consider is when transactions fail. Pathak says: “While this is less of a risk in credit, there are costs when a deal falls through and when due diligence is being conducted on behalf of co-investors as well as the commingled fund, you need some way to attribute those abort costs appropriately.” When it comes to actually making the investments, there are legal considerations about how to structure the transaction. Ajay Pathak says: “Some co-investment arrangements are structured directly at the holding company level, though this can raise some issues that need to be considered, such as making it harder to extract carried interest.”
Read the Private Debt Investor article for more.