Co-Investment

Co-investment represents direct investment alongside a search fund manager or private equity sponsor in a specific portfolio company acquisition, providing investors access to institutional-quality deals with enhanced economics and alignment compared to traditional fund structures. For sophisticated investors seeking private market exposure, co-investment opportunities offer lower fees, higher transparency, and direct ownership in operating businesses.

Co-Investment Structure and Mechanics

Search Fund Co-Investment Model:

Transaction Example: $8M Manufacturing Services Company
├── Searcher Equity: $400,000 (5%)
├── Search Fund Investors: $1,200,000 (15%)
├── Co-Investors: $2,400,000 (30%)
└── SBA Debt Financing: $4,000,000 (50%)

Co-Investor Economics:
├── Management Fee: 0% (vs. 2% in traditional PE)
├── Carried Interest: 10-15% (vs. 20% in traditional PE)
└── Direct Ownership: Pro-rata board representation

Investment Minimums and Access:

• Typical minimums: $25,000-$100,000 per deal
• Investment timeline: 60-90 day commitment period
• Due diligence access: Full data room and management presentations
• Professional oversight: Leverages search fund manager's analysis

Advanced Co-Investment Economics

Fee Advantage Analysis:

Traditional PE Fund vs. Co-Investment Comparison:
$100,000 Investment over 7 Years

Traditional PE Fund:
├── Management fees: 2% × $100K × 7 years = $14,000
├── Carried interest: 20% of profits above 8% hurdle
├── Other fees: Transaction and monitoring fees
└── Total fee drag: ~4-6% annually

Co-Investment Structure:
├── Management fees: 0%
├── Carried interest: 10-15% (no hurdle rate)
├── Direct expenses: Pro-rata share only
└── Total fee savings: $20,000-$35,000 over hold period

Alignment Enhancement:

Search Fund Co-Investment Alignment:
├── Searcher personal investment: Typically $50,000-$200,000
├── Co-investor board participation: Direct oversight rights
├── Information transparency: Monthly/quarterly reporting
└── Exit timing alignment: Shared liquidity preferences

Risk and Return Profile

Enhanced Risk Assessment:

• Concentration risk: Single company exposure vs. fund diversification
• Due diligence reliance: Dependent on lead sponsor's analysis quality
• Liquidity timing: No secondary market until business exit
• Operational involvement: May require more active monitoring

Return Enhancement Factors:

• Reduced fee drag: 200-400 basis points annual improvement
• Direct upside participation: No fund-level hurdle rates
• Shorter commitment periods: 5-7 years vs. 10+ for traditional funds
• Strategic input capability: Direct influence on business decisions

Co-Investment Due Diligence Framework

Lead Sponsor Evaluation:

Search Fund Manager Assessment:
├── Track record: Previous deals and outcomes
├── Industry expertise: Relevant sector experience  
├── Network quality: Board advisors and industry contacts
├── Operational capabilities: Post-acquisition value creation
└── Alignment incentives: Personal capital commitment

Transaction-Specific Analysis:

Business Quality Assessment:
├── Financial performance: EBITDA growth and margins
├── Market position: Competitive advantages and moats
├── Management team: Depth and succession planning
├── Growth opportunities: Organic and acquisition potential
└── Risk factors: Customer concentration and cyclicality

Sophisticated Co-Investment Strategies

Portfolio Construction Approach:

Diversified Co-Investment Portfolio:
Target Allocation: $250,000-$500,000 total

Industry Diversification:
├── Manufacturing/Industrial: 30-40%
├── Business Services: 25-35%
├── Healthcare Services: 15-25%
├── Technology Services: 10-20%

Geographic Spread:
├── Midwest/Southeast: 40-50%
├── Northeast/Mid-Atlantic: 25-35%
├── West Coast: 15-25%

Investment Timing:
├── Year 1-2: 2-3 investments
├── Year 3-4: 2-3 additional investments
└── Ongoing: Replace maturing investments

Risk Management Framework:

Co-Investment Risk Controls:
├── Maximum single investment: 20% of total allocation
├── Minimum diversification: 5+ investments across sectors
├── Lead sponsor limits: Max 40% with single manager
├── Vintage year spread: Investments across multiple years
└── Reserve allocation: 10-15% for follow-on investments

Tax Optimization for Co-Investors

QSBS Qualification Strategy:

Qualified Small Business Stock Benefits:
├── Potential tax exclusion: Up to $10M per investment
├── Holding period requirement: 5+ years minimum
├── Active business test: Operating company (not holding company)
└── Gross assets test: <$50M at investment date

Pass-Through Structure Advantages:

• Direct K-1 reporting: Flow-through of business income/losses
• Depreciation benefits: Pro-rata share of asset depreciation
• Interest deductions: Acquisition financing pass-through
• Exit timing control: Choose tax recognition timing

Co-Investment Platform Evaluation

Institutional Co-Investment Platforms:

Platform Assessment Criteria:
├── Deal flow quality: Volume and sourcing consistency
├── Due diligence standards: Professional analysis depth
├── Fee transparency: All-in cost structure clarity
├── Track record: Historical performance and outcomes
├── Investor services: Reporting and portfolio management
└── Minimum investments: Accessibility for individual investors

Direct Manager Relationships:

Search Fund Manager Partnership:
├── Deal-by-deal basis: Individual transaction evaluation
├── Relationship development: Multi-deal partnership potential
├── Direct communication: Regular business updates
├── Board observation rights: Governance participation
└── Exit coordination: Aligned timing preferences

Performance Benchmarking

Co-Investment Return Expectations:

Risk-Adjusted Return Analysis:
Base Case: 15-20% net IRR
├── Business performance: 10-15% operational improvement
├── Multiple expansion: 1.2-1.8x EBITDA multiple growth
├── Leverage paydown: 2-3% annual IRR contribution
└── Fee savings benefit: 2-4% annual IRR enhancement

Stress Case: 5-10% net IRR
├── Flat business performance: No operational improvement
├── Multiple compression: Market valuation decline
├── Extended hold period: 8-10 years vs. 5-7 year base case
└── Still positive due to: Reduced fee drag vs. traditional PE

Operational Involvement and Value-Add

Co-Investor Participation Models:

Passive Co-Investment:
├── Quarterly reporting: Financial and operational updates
├── Annual meetings: Management presentations and strategy
├── Exit consultation: Input on timing and process
└── Time commitment: 2-4 hours annually per investment

Active Co-Investment:
├── Board observation rights: Monthly meeting participation
├── Strategic input: Growth initiatives and capital allocation
├── Network introduction: Customer and vendor connections
├── Expertise sharing: Industry knowledge and best practices
└── Time commitment: 4-8 hours monthly per investment

Key Considerations for Co-Investors

Advantages:

• Enhanced economics: Lower fees and higher net returns
• Direct ownership: Transparency and control vs. fund structures
• Institutional access: Leverage professional manager expertise
• Flexible minimums: $25K-$100K vs. $1M+ traditional PE minimums

Disadvantages:

• Concentration risk: Single company exposure per investment
• Due diligence dependency: Reliance on lead sponsor analysis
• Operational complexity: Direct ownership administrative requirements
• Limited diversification: Requires multiple investments for risk management

Optimal Investor Profile:

• Investment capacity: $250K+ total allocation across multiple deals
• Risk tolerance: Comfortable with 5-7 year illiquidity periods
• Due diligence capability: Ability to evaluate lead sponsors and businesses
• Portfolio context: Part of broader alternative investment allocation

Implementation Best Practices

Getting Started Framework:

1. Education phase: Study search fund model and co-investment structures
2. Platform research: Evaluate reputable co-investment opportunities
3. Initial investment: $25K-$50K first deal to understand process
4. Relationship building: Develop ongoing partnerships with quality managers
5. Portfolio scaling: Target 5+ investments for adequate diversification

Ongoing Management:

1. Performance monitoring: Regular review of business metrics and progress
2. Reinvestment planning: Prepare for distributions and follow-on opportunities
3. Tax coordination: Work with advisors on QSBS and optimization strategies
4. Exit preparation: Participate in strategic planning and timing decisions

Co-investment represents a sophisticated alternative investment strategy that provides accredited investors access to institutional-quality private market opportunities with enhanced economics and alignment. Success requires careful manager selection, adequate diversification, and long-term commitment to the illiquid investment model.