A report by placement agent Triago in June found that about one in three private equity firms were either charging or intending to charge for co-investments, compared with fewer than one in four that said the same in 2015.
The report found that those that charged tended to levy a fee of around 1% on the invested capital and take a 9% slice of deal profits – less expensive than investing in a fund, which would charge about double that, but not free.
Figures from Preqin show the prevalence of levying fees is even higher, with around half of all private equity firms charging some sort of fee on co-investment. These figures are likely to include a group that don’t have a fund but instead ask investors for cash when they find an interesting investment, on a deal-by-deal basis.
Even when co-investments are free, there are still expenses that investors must pay. Eamon Devlin, a partner at law firm MJ Hudson, said he had seen one manager charge around $ 300,000 for setting up a co-investment vehicle, when a figure of under $ 100,000 should be standard.
Devlin said: “Even when the co-investment funds don’t have management fees, sometimes they do have quite big establishment costs. And, as investors are paying those costs, you could argue that it’s a management fee through the back door.”
Although such a trend may alarm investors, there is some logic behind it.
Buyout firms are quick to point out that there is a cost to sourcing and performing due diligence on investments. Investor relations partners report intense demand for co-investments, which often outstrips supply. Charging for such investments would be one way of regulating demand, says Antoine Dréan, chairman of Triago and founder of Palico.
“Too large a proportion of private equity investment is now earmarked for co-investment for [firms] not to charge for it,” Drean said.
Even so, investors and buyout executives agree that a major reason that investors have been slow to push back on relatively high fund fees – up to 2% of the value of the fund per year and a 20% cut of the profits over a certain amount – is because of the free nature of co-investment deals.
These fees already generate large revenues for many private equity firms. Advent International charges a 1.5% annual management fee on its $ 13 billion fund. This means the firm brings in about $ 195 million per year in management fees alone, even before it takes a slice of deal profits. The firm has around 180 investment professionals, according to its website, meaning that investors pay over $ 1 million per investment professional per year.
Nick Warmingham, senior investment director at Cambridge Associates, said it would be a “bit egregious” for a private equity firm to charge for co-investments. He encouraged buyout firms to see the positives of providing free co-investments, especially because it can help them raise new private equity funds.
Warmingham said: “That demand for co-investment from [investors] does help managers more generally in the sense that if they can promise – not guarantee – [investors] that there will be co-investment, it does really help them raise their fund.”
Corentin du Roy, a managing director at HarbourVest Partners, said that if a private equity firm started charging for co-investment, the firm might start doing the wrong types of deal just so that it could earn the fees.
“I understand the temptation, but I think it would potentially be the wrong incentive if they were earning fees on co-investments”, du Roy said. “Co-investment is a way for [firms] to extend their reach and do bigger deals. It is something that is beneficial for them. If we move to a market where you charge for co-investments they would potentially be tempted to do deals just to generate these fees.”