Club deals, often used by private equity managers prior to the ’08 financial crisis, are a thing of the past. The new kid on the block is the co-investment deal, which over the last four or five years has been gaining real traction with institutional investors.
Speaking with Private Equity Wire, Corentin du Roy (pictured), Managing Director at HarbourVest and one of the leaders of HarbourVest’s co-investment opportunities in Europe, says that co-investments are now an established part of an investor’s allocation.
“Over the past four or five years, a large majority of LPs see the benefit of having 10 or 20 per cent of their private equity allocation going into co-investments. Some can do it by themselves, others need to outsource (and rely on the expertise of investment groups like HarbourVest), but either way it has become a key part of an investor’s private equity allocation strategy.
“We don’t have to evangelise on the merits of co-investment anymore,” says du Roy, who focuses on buyout, growth equity, and mezzanine transactions in Europe.
HarbourVest has a global co-investment team of approximately 30 people, of which six are based in Europe. The firm invests directly into companies, alongside GPs, on both the equity and credit side, partnering with lead investors that it knows and trusts; something that cuts both ways in this area of the marketplace.
As du Roy explains, HarbourVest tries to align with a lead investor who has the track record and the expertise to both create and add value in investments.
“We have commingled pools of co-investment capital as well as separate accounts, that focus on co-investment opportunities. Also, in our primary fund products, we have a carve-out for co-investment. We therefore have a variety of capital pools that we use for co-investing. The majority of capital, however, comes from co-investment-focused funds or separate accounts,” confirms du Roy.
To underscore the attraction of this investment style, HarbourVest recently confirmed the final close of its fourth co-investment fund, with a hard cap of USD1.75 billion. The fund – HarbourVest Partners Co-Investment IV – had an original target of USD1.0 billion and a hard cap of USD1.5 billion, which was raised to USD1.75 billion during fundraising, with the support of limited partners.
Peter Wilson, Managing Director and member of the Executive Management Committee, HarbourVest, was quoted as saying: “We’re excited by the confidence our clients have placed in us that resulted in such a successful fundraise. HarbourVest has been investing directly in companies since 1983 and our co-investment funds capitalise on the general partner relationships we have built since then. These relationships allow us to provide clients with access to a strong and diverse pipeline of global investment opportunities in an ever-evolving private equity market.”
The fund has invested approximately 30 per cent of its capital to 11 co-investments alongside lead sponsors diversified across the Americas, Europe, and Asia. The fund’s initial investments include the acquisition by EQT Partners of Press Ganey, a healthcare database company, and a co-investment alongside ABRY Partners in Acrisure, a national retail insurance broker.
On average, HarbourVest invests USD1.5 billion to USD2 billion in co-investment deals per year.
There are three main reasons for why people do co-investments.
Firstly, for those who don’t have highly built-up portfolios, it gives them diversified exposure to some of the best private equity managers in the world. Each of HarbourVest’s co-investment funds will typically have 20 to 30 underlying companies in the portfolio, diversified by geography, by size of investment, by industry sector and so on.
Secondly, it is a very cost-efficient approach to private equity investing. Typically, co-investing is about 40 to 50 per cent more cost-efficient than getting direct exposure to a mid-market private equity fund, according to du Roy. In today’s age of greater focus on costs and fees, this goes some way to explaining why co-investing is becoming an important component of an investor’s PE allocation.
“Thirdly, a co-investment portfolio offers compelling risk-return characteristics provided the investor has access to abundant deal flow, follows a disciplined diversification strategy and has experience in selecting attractive opportunities.
To give some context to the extent of work that goes into identifying the right opportunities, over the past 12 months du Roy and his team have sourced 525 co-investments, of which only a tiny fraction have led to investments; less than 10 per cent.
“We source a lot of opportunities where lead investors are looking for extra capital to complete a transaction and we have a process of analysing the deal, the co-investment profile, to determine whether we want to pursue it or not. We take an active co-investment approach, building a global diversified portfolio in a way that we think makes sense for our clients,” comments du Roy.
HarbourVest Partners Co-Investment IV has more than 100 investors from across a range of geographies including Australia, China, Colombia, Korea, Israel, Peru, Switzerland, the United Kingdom and the United States. It includes institutional clients such as private and public pensions, corporations, foundations, and family offices, as well as clients through private distribution partners.
Discussing what key metrics have to be considered before proceeding to complete a co-investment deal, du Roy cites two examples.
The first relates to a term referred to above, the ‘co-investment profile’.
It is, says du Roy, imperative that HarbourVest invests alongside not only very good PE managers but those whose underlying lead partner within that group is exceptional. Who are they? What is their track record in that sector? What value creation strategy do they follow?
“When you have the luxury of choosing among hundreds of transactions, you can optimise for really backing the most talented deal professionals in the market.
“Secondly, it might sound obvious, but we only want to invest in high quality businesses. In a market where prices are elevated, sticking to high quality companies is critical. We tend to shy away from cyclical businesses such as those impacted by commodity prices. We prefer businesses that we think will do well during the next recession,” explains du Roy.
Within private equity, HarbourVest covers the full spectrum of deals, starting from growth equity, which might involve financing the growth of companies, small-cap buy-outs, mid-cap buy-outs, all the way through to large-cap transactions.
Some of the deals will be turnaround value deals, some will be more oriented towards growth “because we are aligning ourselves with investors that focus on these different strategies,” adds du Roy.
The discussion quickly switches to club deals. Why the demise?
As du Roy explains, back in ’06 and ’07, private equity practitioners began to receive a lot of criticism for doing club deals because it raised questions over who was really creating the value. Who was doing the work when things got tough? That’s not easy to answer when you’ve got four or five GPs involved in a club deal all looking at each other and not wishing to get their hands dirty.
Lessons were learned during that time and post-08 interest in the club deal faded away.
“In the current market, there are plenty of deals that lend themselves to co-investing rather than club deals, that require more equity than PE managers doing the deals have at their disposal. The evolution of professional co-investors, or professional co-underwriters, means that even for situations where a GP can only bring a third of the equity required, for example, they can still find a pool of professional co-investors to share the deal.
“You never really want to share a good deal with a competitor. Co-investing gets around that issue,” outlines du Roy.
The option of going to professional co-investors to write a cheque for USD500 million simply didn’t exist; at least not to the extent it is today.
Now, the concept of co-investing has become ingrained in the minds of PE managers. They know who the professional co-investors are and they know who they prefer to work with.
This has worked to HarbourVest’s advantage.
“When a manager co-underwrites with someone, you have to be there when they submit the final bid. If you drop out a week before the deal is about to be finalised, they aren’t likely to have enough time to find someone else. The reliability, transparency and trust of a co-investor is absolutely key to a PE manager.
“That’s great for us because we have a team of 30 professionals who have the investment capabilities to be that partner,” says du Roy.
Club deals still happen. Typically though, there will often be a maximum of two maybe three sponsors involved. And even then, it is likely because they have built relations in a particular sector and share the same expertise; maybe they’ve done deals together in the past and continue to work in tandem.
Most of the time, says du Roy, you will see PE managers partner up with maybe a Canadian pension fund, or an investment group like HarbourVest, to do a co-investment deal; anyone who can write a substantial cheque, work fast, deliver underwriting expertise, and can take their share of deal expense risk as well.
In many ways, then, co-investing is a natural evolution of private equity investment. It is synergistic, in the sense that one is able to lower the cost of exposure to private equity. And at the same time, an LP gets to learn more about PE managers in terms of the deals they do. Watching them in action delivers insights that are incredibly valuable.
“Everyone gives the same marketing pitch, it’s only when they are in action that you see the difference between higher quality private equity firms and other private equity firms,” says du Roy.
He says that once you’ve demonstrated that you are a reliable, transparent partner, GPs will keep coming back to do further deals.
“Co-investing helps to extend your relationship beyond just the investor relations team. You get to know the deal lead of the firm. These people care a lot about the deals they do. They have to trust you as a co-investor and if they do, and they enjoy working with you, they will come back.
“It changes the relationship with GPs and helps us to grow our market share,” concludes du Roy.
