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SEC’s broken deal expenses may stymie investor appetite for co-investments

'Disturbingly' quick SEC rule changes may work against investor interests.

The appetite for co-investments will likely wane if proposed Securities and Exchange Commission transparency rules mean the prospect of broken deal expenses for participants, say CFOs and service providers.

“That’s going to be one of the biggest issues between front office, back office and the LPs,” said a panelist in a well-attended session at the CFOs & COOs New York Forum, which was held under Chatham House rules.

“The chance that [investors are] going to be hit with, say, $50,000 of broken deal expenses is going to greatly reduce their appetite for co-invest. There’s going to be a reallocation of risk,” said another speaker. Referring to the SEC timeline, he added: “This may happen as early as mid-2023. It’s a really quick turnaround, almost disturbingly quick.”

The SEC’s proposed changes to the Investment Advisers Act of 1940 seeks to increase transparency, competition and efficiency. Any broken deal expenses would be shared among participants under the current proposal, which has yet to be finalized.

Co-investments are seen as a lifeline for both GPs and LPs, providing hard-to-secure capital at lower cost to investors.

“The LP will be a little bit more hesitant to go into the deal,” said a third panelist. “You’ll need to lower the amount of LPs you can turn to, or you end up changing the fee structure. Maybe you’ll have LPs that demand rights to co-investment. There’s going to have to be some shakeout.”

Market players are frustrated that the SEC isn’t recognizing that “the $250,000 LP is any different from my $50 million one,” said another speaker. “The LPs are going to have realize that the cost is going to go up. The SEC says you’re going to have to pay for it, to take the risk the deal isn’t going to close.”

This was seen as potentially working against the interest of the investors. “LPs are going to want some co-investment, but you may see a shift away from the one-off deal… and maybe you have some sort of sidecar vehicle [to which] they have to commit a certain amount,” noted one panelist. “Operationally, it’s easier to allocate fees or expenses to that vehicle.”