The co-investing conundrum for emerging managers

Over half of the investors canvassed in the sixth annual Buyouts Emerging Manager Survey, conducted in partnership with Gen II Fund Services LLC, are looking to co-invest alongside the emerging managers they back. Indeed, 87 percent expect to complete at least one co-investment alongside a young firm next year and 40 percent plan to execute on upwards of three co-investment transactions.

“Access to co-investment can be one of the rationales for backing emerging managers,” says Sarah Sandstrom, partner at Campbell Lutyens. “Those LPs that come in at a first close, in particular, will be considered for preferred co-investment rights, potentially at a ratio of one-to-one of co-investment to committed dollars.”

Paul Newsome, private equity partner and head of portfolio management at Unigestion, says his firm gets a lot of co-investment dealflow from emerging managers because of the strong relationship established early on, and often because the emerging manager requires a partner with whom they can co-underwrite deals.

GHK Capital, for example, which closed its maiden fund on $410 million this year, actually plans to deploy around double that figure, writing equity checks of up to $250 million in any one deal. “Our fund is functionally undersized,” says managing partner Gil Klemann, “which means co-investment is a very important part of our story. Co-investment can be a useful driver of a first-time fundraising.”

John McCormick, partner at Monument Group, agrees: “As LPs have become more active on co-investing across the board, it has become part of the conversation from the outset. Co-investment has become a way of engaging with new investors. It also allows investors to dig into the way a manager invests and operates.”

McCormick issues a word of caution, however, pointing out that emerging managers must weigh the benefits of using co-invest to help close a fund and get a firm up and running with the economic consequences of offering co-investment on a no-management-fee, no-carry basis. “Co-investment can be a great way to engage, but a balance must be carefully struck.”

Meanwhile, appetite for emerging manager co-investment mirrors demand in the wider portfolio, with 82 percent of LP respondents citing a target co-investment allocation of at least 10 percent. A quarter of all respondents have an allocation target of upwards of 20 percent and for 11 percent the target is 50 percent plus.