What Is a Co-Investment Fund and How Does It Work?

Co-investment funds represent a collaborative approach within the landscape of investment vehicles, particularly prevalent in private markets. This structure enables multiple parties to participate alongside one another in specific investment opportunities, rather than through a single, commingled fund. It facilitates the pooling of capital for targeted deals, offering a distinct avenue for deploying investment capital. This method allows for a more direct engagement with individual assets or companies, diverging from traditional fund models where capital is committed to a blind pool of investments.

Defining Co-Investment Funds

A co-investment fund involves investors committing capital directly into specific portfolio companies or assets, alongside a lead investor, typically the main fund of a private equity firm. This direct participation signifies that an investor participates alongside another party in a particular transaction. This distinguishes co-investments from traditional commingled funds, where investors commit capital to a diversified pool without prior knowledge of specific underlying assets.

Co-investments evolved due to the increasing size of private market deals and investors’ desire for direct asset exposure. This structure offers greater transparency than blind pool funds. While often associated with private equity, co-investment principles apply to other asset classes like real estate or venture capital when multiple parties invest directly. A primary driver for co-investments is to allow the lead sponsor to undertake larger investments or manage concentration risk within their main fund.

The Parties Involved in Co-Investments

In a co-investment arrangement, the General Partner (GP), or lead sponsor, is typically a private equity firm or investment manager. The GP identifies, vets, and manages the underlying investment, often initiating the co-investment opportunity. They act as the active manager, making investment decisions and overseeing the portfolio company’s operations.

Limited Partners (LPs) commit capital directly to the specific deal alongside the GP’s main fund. These investors are often institutional entities like pension funds, endowments, foundations, and family offices, but high-net-worth individuals can also participate. LPs typically take a passive role, providing capital without direct involvement in the portfolio company’s day-to-day management. Their liability is generally limited to the amount of capital contributed.

Other parties may also engage in co-investments, including other private equity funds or strategic partners who bring industry-specific expertise and capital. Multiple co-investors allow for greater capital deployment in a single transaction and can help diversify risk for the lead sponsor.

Common Structures of Co-Investment Funds

Co-investments can take various structural forms. A common approach is a direct co-investment, where Limited Partners (LPs) invest directly into a portfolio company alongside the General Partner’s (GP) main fund on a deal-by-deal basis. This structure provides LPs with direct ownership in the target company. Direct co-investments can be either “active,” with ongoing co-investor involvement, or “passive,” where their involvement is limited.

Another prevalent structure is a dedicated co-investment fund. This fund pools co-investment capital from multiple LPs for multiple deals. Unlike single-deal direct co-investments, these dedicated funds allow for a portfolio approach, offering LPs access to a diversified set of opportunities managed by a single GP.

Co-investment can also involve different types of capital, such as equity co-investments, where investors acquire a minority ownership stake. Debt co-investments or hybrid structures combining debt and equity may also exist. Legal vehicles commonly used include limited partnerships and limited liability companies (LLCs). These frameworks facilitate capital pooling and define rights and obligations for co-investors and the GP.

Management and Compensation in Co-Investment Funds

The General Partner (GP) manages co-invested capital. The GP maintains operational oversight of the portfolio company, makes strategic decisions, and handles reporting to co-investors. This management often occurs alongside the GP’s primary fund, leveraging the same expertise and resources. Co-investors, while having direct exposure, generally hold minority positions and do not participate in day-to-day decision-making.

Compensation structures in co-investment funds differ from traditional private equity funds. Management fees are typically lower for co-investments, ranging from 0% to 1% of invested capital, compared to the standard 1.5% to 2% in main funds. Some direct co-investments may even have no management fees. This fee reduction attracts co-investors, enhancing potential net returns.

Carried interest, the share of profits paid to the GP, also tends to be lower in co-investment arrangements. While a typical private equity fund might charge 20% carried interest, co-investment funds often feature a reduced rate, sometimes around 10% to 12.5% of profits above a hurdle rate, or even no carried interest for certain direct deals. This preferential fee structure aligns interests and incentivizes LPs to participate. From a tax perspective, carried interest is generally treated as capital gains rather than ordinary income. Co-investor governance often includes receiving regular performance updates, though their influence on strategic decisions or exit timing can be limited compared to the lead GP.

The Parties Involved in Co-Investments

Limited Partners (LPs), or co-investors, are the entities that commit capital directly to the specific deal alongside the GP’s main fund. These investors are often institutional entities such as pension funds, endowments, foundations, and family offices, though high-net-worth individuals can also participate. LPs in a co-investment typically take on a passive role, providing capital without direct involvement in the day-to-day management of the portfolio company. Their liability is generally limited to the amount of capital they have contributed.

Beyond the primary GP and LP, other parties may also engage in co-investments. This can include other private equity funds that join a deal, or strategic partners who bring industry-specific expertise in addition to capital. The involvement of multiple co-investors allows for greater capital deployment in a single transaction and can help diversify risk for the lead sponsor. These various participants collectively contribute to the capital base and expertise necessary for executing the targeted investment.

Common Structures of Co-Investment Funds

Co-investments can take various structural forms, each designed to accommodate different objectives and levels of investor involvement. A common approach is a direct co-investment, where limited partners (LPs) invest directly into a portfolio company alongside the General Partner’s (GP) main fund on a deal-by-deal basis. This structure provides LPs with direct ownership in the target company, bypassing the traditional fund vehicle for that specific investment. Direct co-investments can be either “active,” where co-investors have ongoing involvement, or “passive,” where their involvement is limited, often through a special purpose vehicle controlled by the sponsor.

Another prevalent structure is a dedicated co-investment fund, which is a separate fund vehicle established by a GP to pool co-investment capital from multiple LPs for multiple deals. Unlike direct co-investments that are single-deal specific, these dedicated funds allow for a portfolio approach within the co-investment framework. This structure can offer LPs access to a diversified set of co-investment opportunities managed by a single GP.

Co-investment can also involve different types of capital, such as equity co-investments, where investors acquire a minority ownership stake in a company. Legal vehicles commonly used for co-investment structures include limited partnerships and limited liability companies (LLCs). These legal frameworks facilitate the pooling of capital and define the rights and obligations of the co-investors and the GP, ensuring a clear operational and governance structure for the specific investment.

Management and Compensation in Co-Investment Funds

The management of co-invested capital typically falls under the purview of the General Partner (GP) or lead sponsor. The GP maintains operational oversight of the portfolio company, makes strategic decisions, and handles reporting to the co-investors. This management often occurs alongside the GP’s primary fund, leveraging the same expertise and resources for the co-invested assets. Co-investors, while having direct exposure to the deal, generally hold minority positions and do not participate in the day-to-day decision-making processes.

Compensation structures in co-investment funds often differ significantly from those in traditional private equity funds. Management fees, if charged, are typically lower for co-investments, often ranging from 0% to 1% of invested capital, as opposed to the standard 1.5% to 2% charged on committed capital in main funds. Some direct co-investments may even be offered with no management fees at all. This reduction in fees is a significant attraction for co-investors, enhancing potential net returns.

Carried interest, which is the share of profits paid to the GP, also tends to be lower in co-investment arrangements. While a typical private equity fund might charge 20% carried interest, co-investment funds often feature a reduced rate, sometimes around 10% to 12.5% of profits above a hurdle rate, or even no carried interest for certain direct deals. This preferential fee structure aims to align interests and incentivize LPs to participate. From a tax perspective, carried interest is generally treated as capital gains, subject to preferential federal income tax rates (currently around 20% for long-term gains if assets are held for more than three years), rather than ordinary income. Governance for co-investors often includes receiving regular updates on performance, though their influence on strategic decisions or exit timing can be limited compared to the lead GP.