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In recent years a number of prominent private equity fund sponsors in the U.S. and Western Europe have implemented committed co-investment vehicles in connection with their primary leveraged buyout funds. These sponsors have used the vehicles to achieve many different strategic objectives for their firms. However, use of a committed co-investment pool raises several important issues for a fund sponsor to consider.
A committed co-investment pool, or CCP -- sometimes called an overage fund, a side-car fund or an overallocation fund -- shares the same sponsor and management with a lead private equity investment fund. Sometimes, all of the main fund's investors must participate in both the main fund and the CCP, usually on a pro-rata basis pursuant to a preset allocation formula. Other times, only investors who invest a certain minimum size or who have another status designation may participate in the CCP. A CCP can provide the fund sponsor with immediate access to capital for making investments in situations where the main fund cannot provide all of the capital required. This helps the sponsor avoid potential delays, uncertainties, managerial complexities and expenses that can be incurred when it must rely on other sources of capital, such as the traditional co-investment syndication process or multi-investor "club" deals. Sponsors can realize economic benefits by charging carried interest and management fees on CCPs, in contrast to some traditional co-investment arrangements where capital is provided by co-investors on a no-fee, no-carry basis. A CCP also provides the sponsor with increased flexibility in structuring its overall fund offering to investors, since it may have different conditions than those of the main fund. A CCP structured with more favorable terms can be an incentive for investors to commit to the main fund. In addition, structuring the overall fund as a smaller main fund and a CCP may help avoid the "sticker shock" that potential investors might experience with a larger aggregate fund. Often, CCPs are formed to provide capital for the balance of investments made by the main fund once that fund's concentration limit is reached. Sometimes CCPs are established only for investments greater than a specified size, whether or not the main fund's concentration limit has been exceeded. A CCP can also be used to make investments once the main fund's commitments have been exhausted. One prominent sponsor used a CCP to hold a set of pre-identified "warehoused" investments unique from the deals to be made by the main fund. Utilizing a CCP has potential disadvantages. A sponsor may find explaining the mechanics of, and rationale for, the CCP structure complex. A sponsor may also prefer to retain flexibility over which investors to invite to co-invest in a potential transaction. And, if a CCP is intended as a reserve pool for potential deployment into a limited set of transactions, the sponsor may be pressured to charge a below-market rate management fee and carried interest. Similarly, certain investors may prefer the traditional co-investment structure because one-off co-investment opportunities can be more transparent than a blind-pool co-investment vehicle and are not necessarily subject to any sponsor fees. Other issues to consider when establishing a CCP include whether to form the fund as a separate legal entity alongside the main fund or as a distinct pool contained within the main fund. A CCP formed as a separate legal entity may result in added administrative and operational costs and complexities for the sponsor. However, the dual-fund approach provides greater ability to isolate potential liabilities and relative ease to implement distinct economic terms, such as a nonaggregated carried interest calculation. A private equity fund sponsor should also evaluate how the CCP structure will interact with the desires and expectations of investors, as well as the sponsor's own commitments relating to how and to whom it must offer co-investment opportunities. Private equity fund sponsors should carefully consider the important business issues that these structures present both for the fund sponsor and its investors when deciding whether to adopt such a structure. Andrew L. Wright is a partner in the New York office of Kirkland & Ellis LLP. Categories Deal Video
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