What should an LP ask for in co-investment rights next to a fund?
Co-investment rights for an LP involve four document terms: the amount it may place alongside the fund, the fee base that amount carries, the time it has to decide, and access to the same diligence the fund relies on. Rights can win a hesitant commitment when the hesitation is about committing blind to a pool, because the LP still commits to the fund and keeps the option to invest directly. They do nothing for doubts about the manager, and a right that delivers a smaller allocation than expected can leave the fund commitment looking worse than it did at signing.
When a co-investment right can move a hesitant LP
A co-investment right works on one kind of hesitation: reluctance to commit to a pool before the assets are known. The investor commits capital as a traditional limited partner and keeps the right to invest directly alongside the fund.
Institutions may use these rights after they have done diligence on a fund, and family offices that prefer direct investments to blind pool funds are a natural audience for them.
The fund commitment itself does not shrink. An LP that doubts the manager’s underwriting still owes capital to the same manager when called, so a direct sleeve changes the shape of the exposure and leaves the manager question where it was.
Institutional investors commonly negotiate co-investment rights into fund documents, and some managers treat co-investment as contractually required for at least some investors. A request for the right is an ordinary part of fund negotiation.
“By offering co-investment rights, a general partner can often persuade reticent investors to allocate to a fund. The investor would commit capital to the fund as a traditional limited partner investor, but also the investor would retain the right to co-invest alongside the fund directly.”
What the sponsor weighs before granting the right
Granting a right costs the sponsor something real. Co-investment structures add complexity, can divert capital from the fund vehicle, and create expectations for similar arrangements from other LPs.
The last point drives much of the negotiation. A right given to one investor becomes a reference point for every other investor reading the same fund documents.
Sponsors are also expected to commit their own coinvestment into each transaction, whether the deal is a single asset, a joint venture or a fund structure, and the liquidity of their own balance sheets limits how many transactions they can stay active in. Outside co-investment capital is one way a sponsor can pursue deals larger than its own balance sheet would carry, which explains why a sponsor may offer the right as well as resist it.
The terms that turn access into something usable
If a manager grants co-investment rights, the grant is disclosed in the limited partnership agreement. Some agreements carve out a set percentage of the commitment for co-investment, with reduced fees and greater control on that portion.
Four terms decide whether the right has value. The first is the allocation language. Permission to look at a deal, an opportunity to subscribe and a stated dollar amount are three different promises, and only the last fixes how much capital the LP can place.
The second is the fee base. A reduced fee applies only to the capital invested through the co-investment sleeve, so the size of that sleeve sets the saving.
The third is review time. An LP can push for terms that allow it to thoroughly review the potential co-investment and have proper time to evaluate the due diligence documents the fund itself is relying on. The clock should run from delivery of those documents, because a window that starts at first notice shrinks while the LP waits for the file.
The fourth is control. Greater control is a phrase, and it becomes a right only when it names the decisions the co-investor holds.
“For example, an investor may push for terms that allow the LP to thoroughly review the potential co-investment and have proper time to evaluate the due diligence documents that the fund itself is relying on to make a sound investment.”
Carve-out or add-on: what the percentage applies to
A co-investment percentage means nothing until the documents say which amount it multiplies. Two structures can carry the same percentage and produce opposite capital budgets.
In a carve-out, part of an agreed commitment is set aside for co-investment, so total capital to the relationship is unchanged and the fund share falls by the amount carved out. In an add-on, the fund commitment stays whole and co-investment capacity sits on top of it, so combined capital rises.
The carve-out version carries a further question: what happens to reserved capital that no co-investment uses. The answer decides whether that money returns to the LP, goes into the fund or sits idle, and the worked example below shows the cost of the idle case.
Worked example: a carve-out that delivers half the expected co-investment
The hypothetical LP has $10,000,000 to place with one manager. The documents carve out $4,000,000 for co-investment, which is 40 percent of the total, and leave $10,000,000 minus $4,000,000 = $6,000,000 as the fund commitment. Illustrative fee terms: the fund charges 2 percent on the commitment, and the co-investment sleeve charges 1 percent on capital actually invested. Both cases cover one fee period, and returns are left out of the comparison.
Base case: the full $4,000,000 is offered and invested alongside the fund. The fund fee is $6,000,000 multiplied by 2 divided by 100 = $120,000. The co-investment fee is $4,000,000 multiplied by 1 divided by 100 = $40,000. Combined fees are $120,000 plus $40,000 = $160,000. On the $10,000,000 working, that is $160,000 divided by $10,000,000 multiplied by 100 = 1.6 percent.
Stressed case: the manager offers only $2,000,000 of co-investment. The fund fee is unchanged at $120,000 because it is charged on the commitment. The co-investment fee is $2,000,000 multiplied by 1 divided by 100 = $20,000. Combined fees are $120,000 plus $20,000 = $140,000. Unused reserve is $4,000,000 minus $2,000,000 = $2,000,000, which sits idle. Capital at work is $6,000,000 plus $2,000,000 = $8,000,000, so fees on working capital are $140,000 divided by $8,000,000 multiplied by 100 = 1.75 percent.
Total fees fell by $160,000 minus $140,000 = $20,000, which looks like a saving. Measured against capital at work, the cost rose from 1.6 percent to 1.75 percent. The fund fee did not move, so the LP pays the same $120,000 for a smaller share of the intended direct exposure, with $2,000,000 earning nothing.
Common mistakes in reading co-investment rights
Treating review access as an allocation confuses two rights. Access permits evaluation of a transaction, while allocation fixes the amount the LP can invest. A document that grants the first without the second leaves the direct exposure undetermined, however much time the LP has to review.
Applying the reduced fee to the whole relationship overstates the benefit. Each fee has a base. In the example, the 1 percent fee sits on the co-investment sleeve alone, and the 2 percent fee stays on the $6,000,000 commitment whether or not any co-investment arrives.
Reading a carve-out as extra capacity changes the capital budget. A carve-out divides an existing amount, so the fund share falls. An add-on raises combined capital. A percentage cannot answer the budget question until the amount it applies to is identified.
Counting the fee saving without counting idle capital produces the wrong comparison. In the stressed case, total fees dropped by $20,000 while the cost per dollar at work rose from 1.6 percent to 1.75 percent. The cleaner measure divides fees by deployed capital.
Equating the length of a review period with usable diligence time ignores its starting event. A window that begins at notice can be partly consumed while the LP waits for the documents the fund relies on, leaving less time than the stated period suggests.
Questions to put to a co-investment right before relying on it
What exactly does the right provide? Permission to evaluate a deal is distinct from a stated amount available to invest.
What amount does the percentage multiply? The answer shows whether the arrangement divides the existing commitment or adds capacity on top of it.
Where does the right appear in the fund documents? A grant by the manager is disclosed in the limited partnership agreement, so a promise made only in a side conversation sits outside that disclosure.
What starts the evaluation clock? A defined event, such as delivery of the diligence documents the fund relies on, ties the deadline to the information the LP needs.
Which diligence documents does the LP receive? The comparison is between what the LP sees and what supports the fund’s own investment decision.
Which capital bears which fee? Combined economics depend on the dollars in each vehicle and the fee base attached to each.
What becomes of reserved capital that no co-investment uses? Idle money raises the cost per dollar at work, as the stressed case shows.
Does the fund commitment still make sense if direct participation is half of what was expected? That test shows whether the fund obligation stands on its own merits.