At a high level, a co-investment involves a Limited Partner (LP) making a direct investment alongside a partner Venture Capital (VC) fund, typically through a Special Purpose Vehicle (SPV). For General Partners (GPs), co-investments offer an opportunity to bring LPs closer, fostering a stronger relationship. From the LP's perspective (pun intended), co-investments can increase exposure to promising companies, potentially boosting returns. When done properly, co-investments benefit both GPs and LPs. However, poorly managed co-investments can erode the relationship.
Don’t Screw It Up
When an LP invests in a GP, it's often akin to writing a blank check. Beyond the alignment of interests, the LP must trust that the GP’s due diligence process is thorough and consistently applied over time. Essentially, the LP expects the actual investment process to match what they diligenced when making their commitment. While the primary goal of an LP co-investment is to increase exposure to a promising investment, it also allows the LP to evaluate and validate the GP’s deal assessment process.
However, GPs sometimes overlook or neglect the fact that an LP will look at how they do things, which can be detrimental the next time they try to fundraise. If an LP identifies red flags during a co-investment—when the GP should be operating at its highest standards—it probably will raise concerns for the LP.
In theory, an LP should be able to underwrite a co-investment solely based on the work done and provided by the GP. Again, the LP is already trusting the GP with a blank cheque, it’s not too far fetched that an LP would be willing to double down with a little bit of diligence on their main areas of concern. So LPs in theory, don’t need to talk to management or dig too deeply into all the details of a business— everything can come directly from the GP. I say in theory because that’s generally how it’s supposed to work for GPs that know what they are doing. But those are not all GPs.
Seriously— Don’t Screw It Up
A co-investment is an opportunity to solidify the GP-LP relationship. The LP obviously thinks well of the GP (or at least of one of its portfolio companies), to want to increase its exposure. That’s the time for the GP to put its best foot forward and run a great process for the co-investing LP. If the GP does a good job, then that can improve a GPs standing in the eyes of an LP. Or at the very least make the GP a source of co-investing dealflow for the LP— both good things. If the deal does really well and makes the LP money— need I really say more?
On the flip side of that, it’s really easy for a GP’s façade to shatter when a co-investing LP gets to look more deeply at how a GP runs its deals. What does it say about a GP if they can’t answer an LP’s basic question about the business? How does it look if there are mistakes in the GP’s financial models? In those types of scenarios, it’s hard to trust that the GP has their hand on the wheel.
A quick way to get an LP to increase their cheque size during the next fundraise is to run a great co-investment program. A really quick way to lose an LP during the next fundraise, is to run a bad co-investment program. While GPs can’t be faulted for a bad co-investment (since the LP is the one making the decision to invest), they can criticized for how they're run their co-investment and dealmaking process. And since dealmaking is the essence of a venture fund— don’t screw it up.
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None of the above should be considered fund advice, investment advice, financial advice, or legal advice. It is strictly for informational purposes and is accurate to the extent of the author(s) knowledge. The views and writings above are strictly those of the author(s) and do not in any way represent the views of past or present employers.