Allocation Policies

Not all firms abide by a co-investment allocation policy. And those that do have distinct ways of determining allocations. We look at how various models work, which ones offer the best terms for LPs, and policy gray areas.

LP demand for co-investments continues to grow, with the latest data from Probitas Partners¹ showing that 70 percent of LPs take part in direct or co-investments. Of those, roughly half co-invest opportunistically; the others have active internal co-investment programs.

Such high demand presents a challenge for GPs: doing right by their LP co-investing partners and those who invest in vanilla PE funds.

To add to the pressure, regulatory authorities are keeping an eye on potential conflicts and violations of fiduciary duty. The SEC has specifically highlighted its concerns about fee allocations for co-investing vehicles, the potential conflicts surrounding preferential terms in side letters, and the allocation of investment opportunities.²

The ILPA Private Equity Principles, in the updated 2011 version, also weigh in on mitigating potential conflicts for GPs offering co-investments: “The GP should not invest in opportunities that are appropriate for the fund through other investment vehicles unless such investment is made on a pro-rata basis under pre-disclosed co-investment agreements established prior to the close of the fund.”

It’s possible that some GPs won’t follow recommended guidelines and will fail to adhere to a co-investment allocation policy to guide their decisions. Luckily those instances are limited to GPs that aren’t considered “institutional-quality.” Private equity firms that are registered investment advisors are required to create and maintain compliance manuals that delineate their policies and procedures for co- investments.³ Nonetheless, gray areas abound.

In the following tables, we present five common approaches to allocating co-investments and evaluate their pros and cons, for the perspective on an LP. In each case, a clear trade-off exists between efficiency/transparency and satisfying influential LPs.

Which Policy is Best?

Sidecar approaches typically outsource co-investing function to GPs, at the expense of LP flexibility.