Neuberger Berman: Co-investment is the new club deal

As it closes its oversubscribed third co-investment fund on $1.5 billion, Neuberger Berman's head of European private equity, Joana Rocha Scaff, tells Private Equity International why the number of GPs looking to partner with just one, large LP is on the rise and club deals are in decline.

Neuberger Berman closed its third co-investment vehicle last week, beating its initial $1.25 billion target to collect $1.5 billion. The fundraising was oversubscribed. The firm now has $4.8 billion in standalone co-investment assets.

Private Equity International caught up with the firm’s European head and a partner in the co-investing team, Joana Rocha Scaff, to talk co-investment trends. The co-investment team considers around 180 opportunities a year. From this vantage point, Rocha Scaff has identified a bifurcation in the co-investment model where either a GP goes the syndicated route, or, a GP opts for a single, usually large, LP partner to invest alongside it.

The syndicated approach involves GPs striking a deal and taking the equity risk through their fund before distributing segments of the deal to various LPs, normally meaning relatively smaller stakes for the latter.

But the single partner route is gaining greater traction, she believed, pointing to a general decline in the number of club deals.

“The scenario where three or four GPs partner together to do a deal is not a situation you see that often anymore, so GPs are now partnering with large LPs to do a deal.”

A relative dearth of club deals in the latest cycle is down to three factors, she believed.

First, after the huge popularity of club deals in 2005-2007, the aftermath from the global financial crisis left many club investments underwater and GPs at odds in terms of how to solve the issues (or “multiple chefs in the kitchen”, as Rocha Scaff put it).

Second, she said, a number of LPs were annoyed to find themselves investing with GP ‘A’ and GP ‘B’ assuming diversification, only to find the GPs had clustered their exposure, often leaving those LPs heavily exposed to the same underlying companies.

The third has been the impact of the regulator, with the US Securities and Exchange Commission (SEC) alleging collusion between GPs in a number of club deals, leading to a string of significant fines.

“That’s why the largest LPs – with the resources and the capital base – have emerged as a much more viable path for co-investments in the latest cycle.”

But co-investing requires a markedly different skillset for the LP to primary investing. “How to execute co-investments in a professional and responsive manner is the hard part for many LPs because this is not like fund investing, where you can take your time,” Rocha Scaff said.

“Co-investment is an opportunistic transaction; the manager needs capital and you may only have a few weeks to make a decision. If something goes wrong you don’t have a manager to hide behind – it’s your fault because you are selecting the transaction in which you participate.

“You have to understand tangible things; valuation, capital structure, business model, industry and competitive dynamics, growth strategy and whether the exit path is realistic.”

She estimated based on the GPs she speaks with that about half of their investor base say they are keen to undertake co-investments, but when a genuine opportunity comes around, those numbers drop dramatically. 

“For those that even get round to signing the non-disclosure agreement, many others fail to make an investment strictly due to lack of process or resources. There is a meaningful distinction between wanting to do co-invest and really doing it,” she said, although for some, she added, it may simply be that the proposed deal is ultimately unattractive.

Look out for the full interview with Rocha Scaff and Neuberger Berman's head of global alternatives, Anthony Tutrone, in the February issue of Private Equity International, out on 1 February.