Can ‘early-bird’ co-investment rights attract LPs?

Fund advisors that offer “early-bird” investors special co-investment rights may be shooting themselves in the foot, according to multiple market sources speaking to pfm.

Offering early-bird investors (i.e., those who commit before a first close) better access to co-investment opportunities has become an increasingly popular marketing strategy amid tougher fundraising conditions. GPs view the strategy and other first-round sweeteners as a way to gain traction on the fundraising trail.

An investor relations challenge here though is that co-investment rights are a privilege that all LPs in the fund expect to receive, regardless if they committed before a first close, observe fund formation lawyers. The risk in favoring some LPs over others can therefore alienate a percentage of the fund’s investor base.

Many LPs are also adamant about receiving co-investment rights to “have something to wave in front of their committee” as a point of pride, noted one industry funds lawyer. If LPs coming in after the first round are given subordinated co-investment rights they may lose interest in the fund, the lawyer said.

As a workaround, some GPs offering early bird co-investment rights also promise the same rights to other LPs if they commit above a certain ticket size. A problem here though, observe funds lawyers, is that too many LPs given the right of refusal on co-investments becomes difficult to organize. Many LPs “will look interested” in co-investments but ultimately not be able to back a deal, much to the chagrin of other investors as the process is dragged out, said a second funds lawyer. A consequence of this is that LPs actually serious about a co-investment get a shorter time period to kick the tires on a deal, which can harm the LP-GP relationship, the lawyer said.

For more on all things investor relations, including a bigger look into what first-round sweeteners seem to be working on the fundraising trail, see the June edition of pfm.