The continuation/ co-investment conundrum

When is a co-investment not a co-investment? As structures to hold assets for longer rise in popularity, the line between whether LPs should consider these transactions to be co-investments or continuation vehicles is becoming increasingly blurred. So how does an LP know the difference, and does it matter? This is a question affiliate publication Private Equity International­­’s Side Letter team recently put to a number of senior industry participants.

The bottom line is, if an asset is new to a GP, it’s a co-investment; if they already have exposure to the asset as part of the platform, it’s a secondaries transaction, a director at an advisory firm told Side Letter. When it comes to underwriting such deals, the risks aren’t that dissimilar as investors need to look at alignment of interest, value creation strategy and credibility.

Deal volume for continuation funds involving one asset is likely to grow even further given the dearth of exits within private equity, meaning LPs will have a wealth of opportunities for this type of transaction, a senior managing director at an investment firm told us this week. Whether this tidal wave can deliver similar returns to traditional co-investments and therefore deserves to absorb some of the LP capital allocated to the latter, however, is not entirely clear.

“A lot of those deals have really attractive return opportunities by virtue of the expert… taking the second bite and recapitalizing and giving the business new ways to grow through a bigger equity base,” the executive said. “Are those net returns going to end up being the same as no fee, no carry co-invest returns? All that still has yet to play itself [out].”