Co-investment rights have become an increasingly important feature in venture capital and private equity fund agreements, allowing Limited Partners (LPs) to invest directly in portfolio companies alongside the main fund. This article explores the key aspects of LP co-investment rights, their benefits, challenges, and practical implications for both investors and fund managers.
Understanding Co-Investment Rights
Co-investment rights give LPs the opportunity to make direct investments in portfolio companies outside of their primary fund commitment. These rights are typically negotiated during fund formation and outlined in the Limited Partnership Agreement (LPA) or side letters.
Key Characteristics
Investment Structure: Co-investments are usually made directly into portfolio companies, parallel to the main fund's investment, often through a separate vehicle.
Fee Arrangements: Co-investments typically come with reduced fees or no fees at all, in contrast to the traditional "2 and 20" model applied to fund investments. This usually means:
No management fees
Only direct expenses related to the co-investment
Investment Size: Co-investment opportunities usually range from 10% to 50% of the deal size, depending on the fund's strategy and deal specifics.
Benefits for Limited Partners
Economic Advantages
Lower fee burden enhances potential returns
Accelerated capital deployment compared to traditional fund investments
Opportunity to increase exposure to attractive deals
Better alignment with specific investment preferences
Strategic Benefits
Direct exposure to private company investments
Enhanced relationship with General Partners (GPs)
Greater transparency into investment process
Potential for deeper market insights
Benefits for General Partners
Enhanced Deal Execution
Ability to pursue larger deals
Reduced burden on fund concentration limits
Additional capital source for attractive opportunities
Strengthened LP Relationships
Deeper engagement with key investors
Potential for future fundraising success
Improved alignment of interests
Common Structuring Approaches
Pro-Rata Rights: Example: Fund X commits to invest $100M in Company A
Total deal size: $150M
Fund allocation: $100M
Co-investment rights: Up to $50M offered to LPs on a pro-rata basis
Strategic Allocation: Example: Large Pension Fund LP Agreement
Priority co-investment rights up to 25% of each qualifying deal
Minimum deal size: $200M
Notice period: 15 business days
Key Considerations and Challenges
For Limited Partners
Decision-Making Timeline
Quick turnaround requirements (often 10-15 business days)
Need for efficient internal approval processes
Resource allocation for due diligence
Risk Management
Concentration risk in single investments
Limited governance rights
Reduced diversification compared to fund investments
For General Partners
Allocation Policies
Fair and transparent process for offering co-investments
Managing potential conflicts between different LPs
Documentation and compliance requirements
Execution Complexity
Additional administrative burden
Coordination with multiple co-investors
Potential impact on deal timing
Best Practices for Implementation
Documentation Requirements
Co-Investment Agreement
Investment terms and conditions
Governance rights
Exit provisions
Transfer restrictions
Side Letter Provisions: Example Language:
"The LP shall have the right to participate in co-investment opportunities
alongside the Fund in accordance with the following terms:
(i) Pro-rata participation rights based on commitment size
(ii) No management fees or carried interest on co-investments
(iii) 15 business day notice period for decision-making"
Process Management
Deal Notification
Standardized communication protocol
Clear timeline for response
Required information package
Due Diligence Support
Access to data room
Management presentations
Third-party reports
Market Trends and Evolution
Recent Developments
Increasing Standardization
More formal allocation policies
Standardized documentation
Established market practices
Technology Integration
Digital platforms for co-investment management
Automated notification systems
Online due diligence tools
Future Outlook
The co-investment landscape continues to evolve with:
Growing LP sophistication in direct investments
Enhanced regulatory scrutiny
Development of secondary market for co-investments
Co-investment rights have become a standard feature in venture capital and private equity fund agreements, offering benefits to both LPs and GPs. Success in co-investment programs requires careful consideration of structure, process, and resources. As the market continues to mature, we expect to see further refinement of best practices and increased sophistication in implementation approaches.
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