Co-investment may be the word on everyone's lips, but it is not doing the industry any good. That was the view Tim Jones, chief executive officer and deputy chief investment officer at Coller Capital, shared with delegates at EVCA's Investment Forum in Geneva on Thursday.
“The whole co-investment trend is a bad trend,” he said. “More LPs are pushing GPs for co-investments and for co-investment rights sometimes. It is forcing the GP to do bigger deals than their normal strategy deals.”
By satisfying LPs' hunger for co-investments, GPs may be increasing their financial firepower by up to 25 percent or so, he suggested. “[Saying] 'give me some of your overspill' is putting pressure on the GPs to do deals they really shouldn't be doing.”
The comments come at a time when the deal market is becoming increasingly competitive. “There's more competition coming into the market, […] and I haven't seen a big uptick in the number of deals done,” Sachin Date, private equity leader Europe, Middle East, India & Africa at EY, told the conference.
LPs wanting to go direct is pushing up prices, Ralph Wyss, partner and chairman at Gilde Buyout Partners, said. He noted that while it makes sense for end investors to co-invest when a transaction is larger than the sponsor's average ticket size, it “becomes a problem when uneducated people are coming into the market and pushing prices up. This is particularly an issue in the larger part of the market. That pushes larger [players] into the mid-market and pushes our prices up.”
This view was echoed by Ralf Huep, general manager at Advent International. “Of course it is cheaper for [LPs] to invest [directly] just because they are not paying carry now. In reality they are paying higher prices [for assets],” he said. “They are not as educated as we are and will make some mistakes in the years to come.”
Some of the co-investment appetite is coming from LPs trying to lower costs. But there are other drivers too, according to Wyss. “It is largely driven by funds of funds and advisers because their original business model is under a lot of pressure so they are moving into asset classes that yield more value for them, including co-investments and secondaries. That's why you see this push and this push won't go away. It's here to stay, so we just need to adapt to it.”
However, LPs going direct is not necessarily a hindrance for managers, said Joseph Schull, managing director and head of Europe at Warburg Pincus, who also spoke at the event. “It doesn't really affect our business model. We are backing growth businesses in the middle market and [do] complex carve-out transactions. That tends not to be where the sovereign wealth funds and others are doing direct investments today. They [may operate there] in the future, but is not where they are focused on today. We see them typically in the buyout [space] in intermediated auction processes.”
Eric-Jan Vink, head of private equity at PGGM, which is active as a co-investor, defended the practice as being non-competitive to GPs: “It is a good way for us to keep the costs down, like for many other LPs. We are building out our co-investment program but we will definitely be partnering with GPs. I see more LPs and sovereign wealth funds coming into the market. But we are not going to build our own GP. I don't think pension funds should go that way. We won't become another Warburg Pincus.”