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By: Christopher Henry, Lowenstein Sandler LLP
INVESTORS OF MANY DIFFERENT STRIPES ARE EAGER to participate in private equity transactions as equity co-investors alongside private equity sponsors who source, lead, and execute on investment opportunities. These investors hail from portions of the financial landscape as diverse as hedge funds, strategic investors, high net worth individuals, and select limited partners in the sponsors’ funds. Some investment funds themselves are dedicated to making equity co-investments as their primary investment mandate. Direct co-investment opportunities are prized in these investor communities because they offer the potential for superior economic return. Direct co-investments reside outside of the lead sponsor’s fund. As a result, a co-investor’s economic return is not reduced by the carried interest paid by the fund to the sponsor. The trade-off, if there is one, is that investments made outside the fund may result in greater concentration of risk than an investment made in the fund itself, as co-investors will typically invest in only some (and perhaps only one) of the investments made by the fund. Co-investors can mitigate this risk by attempting to build their own portfolio of co-investments, similar to the way a lead sponsor builds a portfolio within each fund.
The market for co-investment opportunities can be quite competitive. A user-friendly reputation and an ability to execute on deals quickly can be important factors in attracting and securing these opportunities. Co-investors typically enter the scene later in the overall timeline of a transaction, after the sponsor has sourced the deal, completed substantial due diligence, and made significant progress in negotiating terms with the target company. Given these circumstances, co-investors may be asked to review and respond to draft documentation on short turnaround times, making decisions about what truly matters, what is a nice-to-have, and what they can live without in the deal’s terms.
This article is intended to provide a guide for co-investors to identify and understand key topics that should be raised in negotiating terms for their co-investments and which initial drafts of the co-investment documents often do not address or address inadequately. This article contemplates a transaction structured as a minority co-investment of typically less than 10% in a private company in the United States. Needless to say, this guide is not intended to cover every issue that could arise in co-investment transactions. Other issues may be relevant depending on various factors, including, for instance, the type of security being acquired, the specific economic terms of the security, and the structure and size of the investment. The focus of this article is to highlight select items that are typically not addressed in the initial drafts of co-investment documents and which most lead sponsors, when asked, will address.
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Christopher Henry is a partner at Lowenstein Sandler in the Corporate Department, and their private equity, mergers and acquisitions, and investment management practice groups. Chris serves as counsel on sophisticated large and middle market deals representing public companies, privately-owned businesses, private equity sponsors and their portfolio companies in mergers and acquisitions, leveraged buyouts, growth investments, dispositions, joint ventures, and equity and debt financings.
For a sample side letter to be used when forming a private equity fund, see
> SIDE LETTER FOR A PRIVATE EQUITY FUND
RESEARCH PATH: Corporate and M&A > Private Equity > Fund Formation and Operation > Forms > Side Letters
For a subscription booklet form to be used when forming a private equity fund, see
> SUBSCRIPTION AGREEMENT FOR A PRIVATE EQUITY FUND
RESEARCH PATH: Corporate and M&A > Private Equity > Fund Formation and Operation > Forms > Subscription Agreements
For an overview on fee and expense disclosure and documentation for private equity funds, see
> PRIVATE EQUITY FEE AND EXPENSE DISCLOSURE
RESEARCH PATH: Corporate and M&A > Private Equity > Fund Reviews and Limited Partner Negotiations > Practice Notes
For a discussion on the various remedies that investors typically negotiate for when investing in a private equity fund, see
> INVESTOR REMEDIES
RESEARCH PATH: Corporate and M&A > Private Equity > Fund Formation and Operation > Practice Notes
For a high-level overview of the attorney-client privilege as it relates to private equity investments and in-house counsel, see
> WHAT SHOULD PRIVATE EQUITY FIRMS BE THINKING ABOUT WHEN IT COMES TO PRESERVING THE ATTORNEY-CLIENT PRIVILEGE?