Everything investors need to know to get started in private equity co-investments

By Jeremy Knox, Senior Investment Director Private Equity at Schroders

Co-investments are a unique segment of private equity which is attracting more and more investors. As traditional investment approaches are being challenged, investors are looking to add to their portfolio tool-kit. A rising number are recognising private equity co-investments as a compelling way to enhance diversification, increase access to exclusive opportunities and optimise risk-adjusted returns.

What is co-investing?

Co-investments are direct investments made alongside a private equity sponsor into a portfolio company. ​ These investments typically take the form of minority equity and, depending on the scale of the co-investor, can provide enhanced governance and information rights.

The rise of private equity co-investments

Co-investments in private equity are not a new phenomenon; they have been a part of the private equity landscape for decades. Historically, these investments were primarily reserved for large institutional investors who had the capital and connections to invest alongside private equity firms in portfolio companies. However, as the private equity market has evolved and matured, co-investments have become increasingly accessible and attractive to a broader range of investors.

Looking at the current trends and statistics, it’s clear that private equity co-investments are on the rise. Co-investments have seen a significant uptick in both volume and value over the past few years. Fundraising for co-investment funds has grown 10x from 2012 to 2022, according to Preqin, and a recent survey showed that 59% of LPs plan to increase allocations to co-investments in the coming two to three years. This growth is driven by several factors, including the desire for investors to have more control over their investments, the potential for higher returns and the opportunity for portfolio diversification.

The benefits of private equity co-investments

Co-investments in private equity offer several compelling benefits. One of the most attractive is the potential for higher returns. By investing directly in a portfolio company alongside a private equity fund, co-investors can often avoid the management fees and carried interest typically associated with fund investments meaning that a larger portion of the investment's returns go directly to the co-investor.

Co-investments also provide access to unique investment opportunities that might otherwise be inaccessible. Many private equity deals, particularly in the middle market, are not widely marketed and are often only available to a select group of investors. By co-investing, investors can gain access to these exclusive opportunities, potentially uncovering high-growth prospects that are off the beaten path.

Where are the opportunities? The attraction of the middle market

We believe the middle market represents a significant and often overlooked segment of the economy. It is typically defined as companies with annual revenues ranging from $10 million to $1 billion. These companies operate across a wide range of sectors and geographies, making the middle market a diverse and dynamic segment. 

Keys to success in co-investment strategies

Implementing a successful co-investment strategy requires careful consideration and planning. It is not simply about identifying attractive investment opportunities; it is also about building the right infrastructure, processes and partnerships to manage these investments effectively.

Challenges and risks of co-investments

While co-investments offer significant benefits, they also come with their own set of challenges and risks. One key challenge is the need for a high level of expertise and due diligence. Co-investors must be able to evaluate potential investments, negotiate deal terms and manage their investments post-acquisition. This requires a deep understanding of the respective industry, the target company and the broader market dynamics.

Co-investments also often require a significant commitment of time and resources. Unlike traditional fund investments, where the fund manager handles most of the investment process, co-investors often need to be actively involved. This can be a challenge for investors who do not have the necessary resources or expertise.

In terms of risks, co-investments can also expose investors to company-specific risk. If the portfolio company underperforms, this can directly impact the co-investor's returns. Additionally, co-investments can also lead to concentration risk if the investor has a significant portion of their portfolio invested in a single company or sector.

Despite these challenges and risks, there are strategies that can help mitigate them. One key strategy is diversification. By spreading their investments across multiple companies, sectors and geographies, investors can reduce their exposure to any single investment. Another strategy is to partner with an experienced private equity firm or co-investment fund. These partners can provide the necessary expertise and resources to manage the investment process effectively.

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