Co-Investment Rights in Fund Investing
Co-investment rights let an LP commit capital to a fund as a traditional limited partner and keep the right to invest directly alongside that fund in individual deals. The right is written into the LPA, and its value depends on four separate terms: which deals are covered, how much notice and diligence access the LP gets, how much capital it may place, and what fees and control apply to the direct position. Managers grant the right to win commitments, and the grant carries costs for the fund and for the manager’s other investor relationships.
Two positions from one relationship: the fund commitment and the direct sleeve
An LP holding co-investment rights commits to the fund on ordinary limited partner terms and keeps the option to write a second, direct check next to the fund in a specific deal. The fund interest is a pooled position run under the partnership agreement. The direct interest is a deal-level position with separate documents, separate fee terms and a separate decision to make.
A general partner can often persuade a reticent investor to allocate to a fund by attaching the right. The investor gets the fund exposure plus a route to put more capital into assets it has seen and likes.
Any such right is disclosed in the LPA.
Some agreements carve out a set percentage of the commitment for co-investment, with reduced fees and greater control. The wording of the carve-out sets the arithmetic. If the percentage comes out of the stated commitment, the amount called into the blind pool is smaller by that share. If the right sits on top of the commitment, exercising it raises the total capital the LP has with the manager.
The two positions overlap in the same asset. An LP’s economic exposure to a deal is its attributable share through the fund plus its direct check, so concentration is the sum of the two even when the fee terms differ.
How widely the right gets negotiated, and where activity is heading
In a sample of institutional investors and managers, 80 percent of prior investor participants reported negotiating co-investment access as part of their fund documents. In the same sample, 45 percent of managers said co-investment is contractually required for at least some investors.
Managers also use the right to widen the circle. Of the managers in that sample, 70 percent allow investors outside their existing fund base to participate in co-investments, which points to co-investment working as a relationship tool as well as a term inside a fund agreement.
Forward expectations were flat to declining. Among prior investor participants, 60 percent plan to continue co-investing. Half expect dollar activity to stay about the same, while one-third expect it to decline. Another 17 percent expect it to increase.
These figures describe a self-selected group of respondents at one point in time. They say little about every LP or every manager, and they carry no promise about later activity.
Large platform managers pair scale funds with co-investments in their pitch, and some say investors have grown more selective about partners who can supply both.
Notice period and diligence access decide whether the right can be used
A co-investment right is only as usable as the time and information attached to it. A drafted clause can require the GP to give all investors written notice of a proposed opportunity at least 15 business days before making it available to third parties, accompanied by the GP’s internal investment memorandum.
That clock measures the LP’s lead over outside capital. It does not by itself fix when the LP must commit funds, and it does not reserve a dollar amount. A clause that gives notice without a response deadline or a sizing method leaves two of the working questions open.
The memorandum gives the LP the GP’s written case. Terms that let the LP review the potential co-investment and evaluate the diligence documents the fund itself relies on give the LP the means to test that case. The difference is the one between reading a conclusion and checking the inputs.
The fund-level position explains why the information terms matter. Investment decisions rest with the GP, and fund investors generally cannot make management decisions or receive the same investment information available to the GP. A co-investment right is one place where an LP can negotiate for closer access on a specific deal.
The working test has four parts. The document should identify the covered opportunities, the information package delivered, the response deadline and the amount the LP may take.
“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.”
What the manager gives up when it grants the right
Granting the right adds complexity for the GP. Each co-investor needs its own documents and a decision process on top of the fund’s own.
It also diverts capital from the fund vehicle. When part of a deal is sized for co-investors, the fund holds a smaller share of that asset, so less fee-bearing fund capital sits in it.
The third cost sits outside the single deal. A grant to one LP creates expectations for similar arrangements from other LPs, and the manager has to price that precedent into every later negotiation.
Against those costs sits the commitment the right helps win. Because the right works as an inducement, a manager weighing it compares a larger or earlier fund close with these frictions.
Pipeline exclusivity is a different right from fund co-investment
Investors in programmatic joint ventures increasingly seek exclusive access to an operator’s pipeline of opportunities in exchange for an equity commitment. The pipeline right ties to a commitment to a venture. Fund co-investment ties to a fund commitment and is exercised deal by deal.
The pipeline right is typically limited to assets that meet pre-agreed criteria, so the criteria define what is covered. The right also terminates if the investor rejects an opportunity.
That termination feature changes the cost of saying no. Declining a single deal under a fund co-investment right ends only that deal’s participation. Declining under an exclusivity right can end the priority attached to every later qualifying asset.
Worked example: $5,000,000 placed through a fund versus alongside it
This hypothetical example puts the same $5,000,000 into the same asset two ways over the same four-year hold. In the fund route the LP bears a management fee of 1.5 percent a year on its $5,000,000 and a carried interest of 20 percent of profit after fees. In the co-investment route the LP pays no fee and no carry. The illustration ignores a preferred return and any other charge to keep the comparison on one basis.
The fund fee is $5,000,000 multiplied by 1.5 divided by 100, which is $75,000 a year. Over four years the fee is $75,000 multiplied by 4, or $300,000.
Base case: the asset returns 1.6 times invested capital. Proceeds are $5,000,000 multiplied by 1.6, or $8,000,000, so gross profit is $8,000,000 minus $5,000,000, or $3,000,000. In the fund route, profit after fees is $3,000,000 minus $300,000, or $2,700,000. Carry is $2,700,000 multiplied by 20 divided by 100, or $540,000, leaving net profit of $2,700,000 minus $540,000, or $2,160,000. That is 43.2 percent of the $5,000,000. The co-investment route keeps the full $3,000,000, which is 60 percent. The gap is $3,000,000 minus $2,160,000, or $840,000, equal to the $300,000 of fees plus the $540,000 of carry. The fees are 10 percent of gross profit.
Stressed case: the asset returns 1.2 times. Proceeds are $5,000,000 multiplied by 1.2, or $6,000,000, and gross profit is $6,000,000 minus $5,000,000, or $1,000,000. In the fund route, profit after the same $300,000 fee is $700,000. Carry is $700,000 multiplied by 20 divided by 100, or $140,000, leaving net profit of $560,000, or 11.2 percent. The co-investment route keeps $1,000,000, which is 20 percent. The gap is $1,000,000 minus $560,000, or $440,000. The same fees are 30 percent of gross profit.
Carry falls with profit, from $540,000 to $140,000, while the fee stays at $300,000. The dollar saving from co-investing is smaller in the stressed case, at $440,000 against $840,000, yet the fee burden on the fund route is larger as a share of what the asset earned.
Both routes carry the same asset risk. The co-investment route also needs the LP to write a second check and make the decision on its own. If the carve-out reduces the fund call, the LP holds a smaller blind pool position as well.
Mistakes that distort the economics and the access
Reading the share of respondents that negotiated access as a share of all LPs overstates how common the term is. The 80 percent figure describes prior investor participants in one sample, and the 45 percent figure describes managers who answered. Neither is a census of funds.
Treating notice as an allocation confuses information with quantity. A 15 business day notice period tells the LP when it learns of the deal. Only a sizing method or reserved amount tells the LP how much it may invest.
Adding the co-investment on top of the fund commitment when the agreement carves it out of the commitment double counts capital. If a set percentage of the commitment is reserved for co-investment, the fund draws less from the LP by that amount, and total capital with the manager stays at the stated commitment.
Applying the reduced co-investment fee to the whole relationship overstates the saving. The reduction covers the direct capital only, and the fund interest keeps its own fee and carry. In the worked example the saving of $840,000 in the base case applies to the $5,000,000 placed alongside and to no other capital in the fund.
Measuring exposure to an asset by the direct check alone understates concentration. The fund share of the same asset adds to it.
Treating a rejection under a pipeline exclusivity right as a one-deal decision ignores its stated feature. If the right terminates on rejection, the LP gives up access to later qualifying assets along with the one it declined.
Questions for reviewing a co-investment right in a fund agreement
Does the right sit inside the commitment or on top of it?
Which opportunities does the right cover?
What amount may the LP take?
Which event starts the review clock and which ends it?
Which documents accompany the notice?
Which capital bears each fee and carry?
What authority does the direct investor hold after entry?
How does rejection affect future access?
What does the grant mean for the manager’s other LPs?