3Qs: GPs Co-Invest with Limited Partners

Financial sponsors continue to call on limited partners to help round out their equity commitments, says Christina Carroll, managing director, investment bank Stout Risius Ross. As a result, co-investing is becoming more popular as LPs look for opportunities to reduce fees and gain exposure to the transactions of private equity players. (Watch the video below.) 

Direct investing by LPs, once prevalent in the 1980s, is making a comeback. As allocations to the asset class grew over time, the need for co-investment capital had diminished. But now, the dynamics of the asset class have changed. There are now more co-investment opportunities.

What remains unknown is how the U.S. Securities and Exchange Commission plans on regulating co-investments. One thing's for sure, Carroll adds: co-investing is expected to increase and, with that, the level of transparency on the part of general partners.

Why are more limited partners co-investing with private equity firms?

Almost 50 percent want to ramp up their private equity co-investing today. And I think there is great interest because they feel like they can drive excess returns in their private equity portfolios. They also like the fact that they can influence sector geography and timing of the deployment of their private equity capital. And an added bonus: It's without management fees or carry. And so from a net internal rate of return perspective, it's more fee-efficient for them.

What's the U.S. Securities and Exchange Commission's reaction?

The SEC has been pretty vocal about being concerned about private equity co-investing. Their concern is that it's offered to their larger LPs and that maybe the little GPs don't get as much of an opportunity. So that hasn't been settled yet. We'll see how that unfolds. But it could be a disclosure matter, where not everybody might get an opportunity to co-invest.

Do you expect LP and GP agreements to change?

I think for those that have SEC findings, there's been a lot in the press about how fees are allocated and how transparent fess are in LP agreements. That may put pressure on them to change, if there's a finding there, just to enhance the clarity.