Private Equity Co-Investment

A co-investment is equity capital committed by limited partners directly into a single portfolio company at the same time the managing partner (general partner) invests via its main fund. Rather than routing every dollar through the fund structure, LPs take a direct stake, typically at lower cost and with more granular control over the deal.

Why co-investments emerged from fee pressure

When a private equity fund deploys capital, limited partners pay management fees on every dollar — typically 1 to 2 per cent annually — whether the investment returns anything or not. For a large, sophisticated LP managing billions across multiple private equity vehicles, this fee drag compounds. In the early 2000s, large pension funds and insurance companies began asking GPs: “Why can’t we invest directly in the deals you’re backing, and skip the fund fee?”

The best answer GPs had was alignment and expertise. The worst was habit and profit. Co-investments solved the tension. They let LPs achieve fee efficiency while keeping the GP’s operational know-how and board seat at the centre of the deal. Today, co-investments are standard in any large PE transaction.

The mechanics of a co-investment

A typical co-investment flows like this. ABC Capital raises a $500 million fund and identifies TechCorp, a software business, as a target. The fund will invest $300 million (its ticket). ABC then approaches three anchor LPs and offers each the chance to co-invest $50 million directly into TechCorp, alongside the fund, on identical entry terms.

The co-investors wire their $150 million straight into the acquisition vehicle. Their equity stake sits alongside the fund’s, and both are entitled to identical economics per dollar invested. Often, the fund buys a 60 per cent stake and co-investors split the remaining 40 per cent. From day one, they own real equity in the company.

Governance varies. Co-investors might receive a board seat, a board observer slot, or simple information rights. Many — especially smaller or passive co-investors — delegate operational decisions entirely to the GP and collect distributions when the company is sold or refinanced.

Management fees on co-invested capital are minimal. The LP might pay 0.5 to 1.0 per cent annually, versus the fund’s standard 1–2 per cent, and sometimes nothing until exit. This saving can be substantial. On a $50 million direct investment held for five years, cutting the fee from 1.5 to 0.5 per cent saves $500,000.

Fee savings versus reduced diversification

The trade-off is stark. A co-investment buys direct exposure to one company. The fund itself holds a portfolio — often 8 to 15 portfolio companies. If the co-investment target thrives, the LP captures full upside; if it fails, the LP loses its entire co-investment stake. A fund LP is hedged by the portfolio.

This concentration risk is why co-investments suit large, sophisticated investors with deep due diligence resources. A pension fund with a dedicated PE team can afford to underwrite a single deal and accept the binary outcome. A smaller LP relying on the GP’s research and oversight should probably stick with the fund itself.

GPs welcome co-investments for different reasons. They reduce the amount of capital the fund itself must deploy, which means less leverage needed to hit return targets. They also signal GP confidence — if the team is willing to co-invest their own capital (which they usually do, via their general partner carry), that’s a strong endorsement to LPs considering co-investment themselves.

Secondary economics and carry

Co-investors in a deal rarely receive carry (the GP’s share of profits). Instead, they receive their pro-rata share of the equity return. If the GP and co-investors both invest on identical terms, they split the exit proceeds according to their pro-rata stakes. If the company sells for $1 billion and the GP + LPs put in $450 million total, profits are split accordingly.

However, some co-investment arrangements are structured as “junior” to the fund’s preferred return. In this case, the fund’s preferred return is satisfied first, and co-investors receive what remains. This arrangement is rarer but can align incentives further — the GP prioritizes the fund’s base economics, and co-investors share in outperformance only if the deal truly beats hurdles.

Co-investments as a gating mechanism

Co-investments also serve as a quality filter. A GP that offers broad co-investment rights is signalling confidence. Conversely, a GP that restricts co-investments to a single large anchor investor, or that structures them in a subordinated way, may be protecting the fund’s returns — a signal that the deal is marginal or the GP expects downside tail risk.

Sophisticated LPs read this signal carefully. If a GP reserves co-investment for itself and a few favoured LPs, newer investors should ask why.

The fund-of-funds perspective

Fund-of-funds managers often negotiate co-investment rights as part of their LP agreement with the GP. This lets them offer their own LPs direct deal access without building an in-house PE operational team. A fund-of-funds might co-invest 10–20 per cent of the fund’s total capital directly into the GP’s best deals, creating a tiered portfolio for their LPs.

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