Friday Letter: The road less travelled

The logic is hard to fault, and the calibre of its proponents suggests that it can only be meaningful. Co-investment by limited partners alongside their GPs looks sufficiently compelling to prompt the question: “why aren’t more people doing it?”  

Part of the answer is that not all limited partners have the capacity, or inclination, to put their money directly into companies. To some it seems inappropriate for them to be doing this. Said one such (overstretched) investment officer to PEO recently: “why have a dog and bark yourself?” In other words: let the private equity firms you are allocating capital to put your money to work.

Another part of the answer as to why not every LP is looking at this kind of parallel investing, is that general partner groups can be more than a little wary of the idea. To some GPs, co-investment by their limited partners erodes the intrinsic value of their fund and its investment proposition. The argument here is that investors should only be able to invest in a particular fund to get access to the assets the GP has identified as having the most potential. It is inappropriate to allow your LPs to ride on the back of your asset sourcing skills and then have them invest in a selected company directly. These GPs will therefore discourage talk of co-investment rights whenever possible.

But many of the most influential, and – inevitably – heavyweight investors in the asset class (take the global funds of fund groups for example) are committed co-investment enthusiasts. Not only have they the internal resources to effectively assess a co-investment opportunity, they also have more than enough capital allocated expressly for this purpose. It’s unsurprising therefore that these groups will expect to make co-investment rights a pre-requisite in any opening discussion with a GP they are considering allocating capital to.

For the newly formed or the track-record-challenged private equity group out fund raising, these discussions are usually a one way street – something that in itself can rankle to an extent that leaves one wondering whether some of these LPs are flexing their muscles a bit too hard. It is also the case that other LPs coming into a fund may find that the heavyweights have won terms that leave these lighter, later joiners markedly further down the food chain. Whether this has any meaningfully negative consequences for the big LPs is probably still a moot point. But PEO was reminded this week that private equity remains an asset class shaped by people – and over the long term – and that as a result one can see the rulebook of co-investment being rewritten over time.  

News that Nordic mid-market buyout specialist Altor Equity Partners had just closed its second fund on €1.15bn was eye-catching for several reasons. One was that here was a firm that had only spun out of longstanding Nordic group Industri Kapital and then rapidly raised a startling €650m first fund three years ago. Raising nearly twice that amount now in a matter of months speaks volumes for Altor’s position in the market.

Another reason that the new fund caught the eye was the fact that the firm insisted that all LPs invested both in the main fund [that totalled €900m] and in a side co-investment fund also [€250m]. This compulsory requirement not only enabled Altor to garner valuable capital to use to support investee companies in their growth plans. It also meant that every LP in the main fund had some co-investment exposure [on a pro-rata basis according to the percentage of their commitment to the main fund]. Unsurprisingly this enforced democratisation of co-investment had some of the LPs up in arms (details of what is a stellar list of investors is available on the PEO story linked to above by the way.) But it is telling that, when a GP has a surfeit of demand for their fund, they chose to at once create a vehicle that will be additive when transforming portfolio companies and to make co-investment an integral part of the investment proposition for everyone. This sets an important and, many would argue, valuable precedent –one that could make co-investing a far more travelled road.

PS: Readers have asked when we shall be releasing the results of our 2005 Global Private Equity Awards. It’s next week: they will be online at PEO on Wednesday 1 March.

PPS: We are also offering new subscribers the chance to sign up to PEO at a 10 per cent discount and get a free copy of our 150 page Annual Review [where the awards are detailed] if they subscribe by 3 March 2006. If you want to take advantage of this great offer, just click here (http://www.privateequityonline.com/subs4.asp)