A more restrictive credit environment is pushing some GPs to offer more co-investments
59% of LPs intend to increase exposure to co-investments – Goldman Sachs
LPs and GPs want to forge closer relationships
February 20, 2024 (Preqin News) – GPs are increasingly looking to co-investments to finance more of their deals with equity, courting LPs with the reduced fees, increased transparency, and rapid capital deployment that co-investments offer.
Market participants report that the rise in interest rates and tighter liquidity have prompted GPs to trim debt financing in favor of more equity to complete private equity buyouts.
According to data from Preqin Pro, the number of funds and aggregate capital raised for private equity co-investment increased substantially in the years leading up to 2021 when interest peaked, with $42.1bn raised between 355 funds that year, an eight-times increase in a decade. However, the growth stalled in 2022 when $38.7bn was raised, and slipped to $15.1bn last year.
‘The equity contribution on the LBOs versus the debt is up quite significantly versus the historical norm, and the leverage is down partially because interest rates are up and partially because credit officers now have more power and are being more restrictive,’ Patrick Kocsi, Co-Head of Co-Investments and Senior Managing Director at Ardian, told Preqin News. ‘There’s more demand for equity to get deals done, and that benefits LPs because that’s what GPs need.’
Amid the wider slowdown in private equity activity, co-investment activity remains relatively robust, according to some market participants.
‘I would have thought deal flow on the co-investment side would have slowed over the past few years, given overall deal activity was down across the PE market. But our deal flow for co-investments has remained steady,’ Champ Raju, Head of Private Equity at PPM America, told Preqin News. ‘It simply requires more equity to close deals these days, given elevated purchase prices and lower debt levels, than it did five years ago. From a GP perspective, it is helpful if they have a stable of LPs who have a dedicated co-investment program that can react quickly, efficiently, and with certainty as co-investment opportunities are presented.’
At the end of January, PPM America closed their eighth co-investment fund at $660m, the asset manager’s largest to date, which will deploy the capital to middle market opportunities across the US.
While co-investments allow GPs to continue investing in opportunities that could otherwise be too large, the strategy is one that LPs have also been warming to.
In a Goldman Sachs survey of more than 200 LPs, published in September 2023, 51% said that co-investments were the private equity strategy they felt the least exposed to, and 59% of respondents said they intended to increase their exposure. Of those surveyed, 58% had no allocation at all to co-investment funds. LPs and GPs indicated that they wanted LPs to forge stronger relationships with fewer GPs to do more co-investment deals.
Among the attractions to LPs is the direct nature of investing in a smaller number of firms. Furthermore, with the current slowed exit environment, liquidity distributions back to LPs have been affected. In a co-investment strategy, funds can be deployed more quickly than in traditional private equity funds of funds, a factor likely to appeal to LPs.
'If you are ramping up your PE program, the quickest and most cost-effective way to get NAV in the ground is to do co-investments alongside your GP relationships. If you commit to a typical GP fund, the GP will deploy that capital in three-to-five years. Whereas, if you do a co-investment alongside your GP relationships, those dollars are in the ground day one,’ PPM America’s Raju said.
While LPs, particularly large public pension funds, have been increasing their exposure to private assets in recent years, some have questioned the relatively high level of fees typically charged by GPs. Fees are typically waived in return for the committal of substantial chunks of capital in co-investments, so LPs can lower their overall fee level by investing through co-investment.
‘Ultimately, the net return is boosted by the fact that GPs typically offer co-investments free of the usual management fees (1.5-2%) and performance fees (20%). This is significant in an asset class known for its high fees,’ David Maréchal, Pictet Asset Management’s Deputy Head of PE and Co-Head of Europe, wrote in a research note last month.
Ardian’s Kocsi said it is important to have both a large network for access to deal flow, as well as deeper relationships with select GPs that have proven track records.
‘What the co-investment platform at Ardian needs is access to as many deals as we can possibly conceive, because we reject 95% plus of the deals that we see. So, if 100 deals come across our desk, we literally pass on 95 of them, even though they all come from good relationships. In order to generate hundreds and hundreds of deals a year, which we do, to be able to down-select to the ones we want, we need this level of broad access.’
The opinions and facts included within the above do not constitute investment advice. Professional advice should be sought before making any investment or other decisions. Preqin providing the information in this content accepts no liability for any decisions taken in relation to the above.