Last year, regulators from the Securities and Exchange Commission raised concern about co-investments. The statements were vague about what was bothering the regulators.
Co-investments allow a private equity to lower its exposure to an investment and give others an opportunity to invest along side the fund at a discounted rate. It can be an opportunity to lure investors into the fund by granting them preferential treatment to co-investments. This would lower the effective management fee costs the investor pays to the manager.
Many fund investor are interested, but its hard to spread the opportunities equally out to all of those interested. Splitting the co-investment equally will result in opportunities being so small per investor that it’s not worth the time, effort and money.
The biggest concern for fund managers is execution. It takes a great deal of effort to put the capital stack together for an acquisition. The fund manager needs a potential co-investor to be able to act quickly and decisively.
From the SEC’s perspective, I assume examiners would not be happy to find fund managers dangling the possibility of co-investments as an incentive for an investor to commit to the fund and then not actually offering co-investments to that investor.
Fund managers need to be honest with investors and let them know where they stand in line for co-investments. If a fund manager has offered priority co-investment rights to certain investors, the manager disclose this.
The other concern of regulators and one which should be a concern is allocating deal costs. If the deal goes ahead, co-investors should pay their portion of the deal costs. Last year, the SEC raised concerns about broken deal costs when co-investments are used on a regular basis. The SEC felt that not all of the broken deal costs should be paid by the fund when co-investments were a routine part of the investing strategy.
Sources:
- Buyout firms’ hushed deals with top investors risk US regulators’ ire by Koh Gui Qing in Reuters
- SEC Official: PE Needs to Be More Transparent About Co-Investments
- Firms Say New SEC Scrutiny May Further Complicate Co-Investments
- Who gets to share? The opaque world of co-investments
- Complications in Co-Investments
- Co-investment Best Practices (pdf)
- How to Allocate Broken Deal Expenses After the KKR Case?