A case against co-investing

Bringing in limited partners on smaller transactions is not necessarily always the best way to generate a strong return, according to mid-market firm Huntsman Gay. Graham Winfrey reports

During the past few years, it’s almost become a truism that limited partners want more access to co-investment opportunities.  Investors have been particularly vocal about this subject, as they chase lower fees and greater bang for their buck. 

At The Blackstone Group, one consequence of this has been fewer club deals. “We would do club deals again, [but] LPs are much more interested today in co-invest,” Blackstone president Tony James said during a recent earnings call. “Buyout sponsors in general would rather give their LPs something they want than give a competitor a piece of a deal.”

Nonetheless, there are still situations where GPs (and their LPs) can generate a stronger return by investing alongside other GPs, even if the deal is small enough to fund via co-investments.

One such example is US mid-market firm Huntsman Gay Global Capital’s recent $30 million investment in Munich-based e-commerce software company hybris, alongside late-stage venture capital firm Meritech Capital Partners and Greylock Israel, an affiliate of US venture firm Greylock Partners. The investment marked a ‘doubling-down’ of sorts for Huntsman Gay, which first acquired a majority stake in the company in 2011.

While a small group of LPs could probably have cobbled together $30 million, for Huntsman Gay, the expertise of the VC firms it brought into the deal trumped the size of the equity cheque.

“In order for us to maximise the most value and deliver an enormous return, we are bringing on a nominal amount of capital, but more importantly real world class names that have done similar things and are going to help us maximise our LPs’ return on a macro level,” says Rich Lawson, co-founder and managing director of Huntsman Gay. 

Within the software and technology sectors, Meritech and Greylock have specific expertise in enterprise software: Meritech was an investor in customer relations software provider Salesforce, while Greylock is an investor in human resource software company Workday, “two wonderful examples of enterprise software disrupters,” Lawson says (hybris is similarly disrupting the commerce software market, he adds: the company has grown revenues at a compound annual rate of roughly 70 percent during the past three years).

As part of Meritech’s investment, its managing director George Bischof also joined hybris’ board of directors. Again, this is about maximising returns by adding “great minds that can add value,” Lawson says. 

Bringing in LPs as co-investors can also create problems in other ways, according to Delaney Brown, head of the Americas at Hermes GPE.

“There is a bit of a disconnect, I think, in that there is currently a relatively limited universe of LPs that are able to consistently co-invest well,” he says. “We have found on quite a few occasions that a GP will come to us and say: ‘We thought we had the equity syndicate sewn up, but [someone] who we thought was going to provide a $20 million ticket is not going to be there and we need to fill the gap.’ We see quite a few deals like that, where LPs have suddenly dropped out because they weren’t appropriately geared up to take on direct investing.”

Co-investment opportunities will continue to be in high demand from LPs – and investing alongside venture capital firms will rarely be a viable strategy. But the hybris deal serves as a reminder that there’s a time and a place for everything. ?