4.4 Evolution of Investing In PE

Question 1

3 main approaches with PE investing?

Answer 1

1) solo investing

2) Partnership investing (invest with 1 or more asset owners/GP in one or more deals over a period)

3) co-investing (asset owners invited by GPs to invest in specific portfolio companies outside the main PE Fund)

Question 2

3 reasons why asset owners pursue direct investment?

Answer 2

1) improve return while managing risk

2) Control & info flow

3) Cost efficiency

Question 3

Direct investment stats

Answer 3

• Co-investments have increased significantly (about doubled) since 2014, while solo investments have not increased.

According to a 2017 Coller Capital Survey, between 2012 and 2018, the percentage of investors making co-investments rose from 42% to 55%, while the percentage making solo investments rose only from 30% to 31%.

Question 4

3 alternatives to co investing:

Answer 4

1) Portfolio companies - LPs invest directly in one or more of the main fund’s portfolio companies

2) Top-up fund - co-invest in the main fund’s future investments. LPs use a GP controlled fund separate from the main fund created to invest in one or more of the portfolio companies selected for the main fund.

• Another approach is annex funds, which are used to co-invest in a fund’s existing portfolio companies.

3) Deal-by-deal co-investment program - specific investments are identified and decisions to co-invest are made on an ongoing and deal-by-deal basis.

Question 5

How is co investing usually carried out?

Answer 5

Via a LLC or Limited Partnership controlled by the main GP

Question 6

Key terms of co investing? Where are the specified?

Answer 6

1) lock step provision - the relationship stays GP-LP

2) bridge financing (bridging) - GP makes an investment for the main fund but agrees to later sell the asset to the co investors

Question 7

3 main co investment fee structures

Answer 7

1) No fees (0% annual management fee and 0% carried interest).

2) 0% annual management fee and 20% carried interest.

3) 1% annual management fee and 10% carried interest.

Question 8

When are low / no fees offered?

Answer 8

They are typically offered to PE funds existing LPs

Question 9

What is “promote” and when do LPs offer it?

Answer 9

Profit-based fee like carried interest, except it is typically associated with specific duties (e.g., creation and marketing of a specific investment opportunity).

Offered instead of paying carried interest

Question 10

Co investing approaches graph

Answer 10

Question 11

Investment process in Fund Vs co investing?

Answer 11

Differs in how sourced and selected

Fund: GP makes selections for the fund

Co investing: LPs select in which they would like to invest after the GP has screened and price invest opportunities

Question 12

When do LPs need to indicate their interest in co investing to the GP?

Answer 12

At the start of the initial fund commitment and continue to express it

Question 13

Even if LPs cant assess the benefits of individual investments, what could they be attracted by?

Answer 13

Potential savings on management fees and carried interest

Question 14

Size of reserve allocations for co investments that are typical for LP portfolio strategies

Answer 14

10-20%

Question 15

Why can smaller LPs struggle to participate in co investing?

Answer 15

Because the minimum contribution can be large.

GPs need large enough contribution to facilitate co investing

Question 16

Co investment / Partnership investment responsibilities during the investment process?

Answer 16

Question 17

8 Pros of Co investing

Answer 17

1) potential superior returns (lower fees and more exposure)

2) targeted investments (more choice)

3) better management of portfolio diversification (choice)

4) mitigating dilution (do not dilute)

5) double level of investment review (GP also reviews)

6) improved monitoring (more info that to standard LPs)

7) forming relationships with invitation only funds

8) reducing J curve effect (in practice difficult, but can occur if investment in early years is reduced)

Question 18

Expected cons of co investing for LPs?

Answer 18

1) unbalanced portfolios

2) higher fiduciary risk (more exposure)

3) Conflict of Interests (LPs may prioritize co investing to main fund investing)

4) Disagreements among LPs

5) Allocation of fees (how will the GP be incentivized)

Question 19

Challenges of co investing from LPs perspective

Answer 19

1) Need to build in house resource and expertise

2) access to co investments

3) reduced diversification

4) organizational constraints

Question 20

Challenges of co investing from GPs perspective

Answer 20

1) mostly talk and no action (only 25% of requested co investments take place)

2) delay in deal process (rounds of opportunities and terms negotiations)

3) additional costs / resources (set up and reporting costs)

4) adverse effect on relationship with other LPs

Question 21

Round robin offerings are?

Answer 21

Multiple offerings of unnacepted co investment opportunities

Question 22

How many GPs offer co investing and how many believe it does not bring value?

Answer 22

2/3 offer, 18% more consider

2% dont believe in the value

Question 23

Why do GPs offer co investments?

Answer 23

1) Build a stronger relationship with LPs.

2) Gain access to additional capital for deals.

3) Improve the chance of successful fundraising.

Question 24

Braun et al (2016) findings in relation to co investing?

Answer 24

1) Buyout and venture capital co-investments outperform their corresponding funds

2) Co-investments’ costs tend to be lower for LPs than funds.

3) There is no evidence of GPs offering lower-quality deals to LPs

4) GPs may use co-investments to cultivate stronger relationships with LPs before the GPs’ next fundraising.

Question 25

Capabilities needed for successful co investing?

Answer 25

1) build internal expertise

2) source own co investments (base of relationships)

3) efficient approval process

4) co investment program risk management (co investments have unpredictable timing and may require additional financing)

Question 26

Alaska permanent fund corporation (APFC) returns and approach?

Answer 26

Target ratio 20:80 direct / co investment and indirect investments

13-19% PE Allocation

Question 27

Co investing possible affect on J curve?

Answer 27

Possibility 1: reduce j curve because of lower (no) fees

Possibility 2: can magnify because of higher st dev of outcomes & back ended distributions (when distributions are made at the end of fund’s life)

Question 28

Of the direct investing approaches which is the most expensive and the most common?

Answer 28

Most expensive: solo

Most common: co investing