Tough economic times often bring a heightened sense of risk aversion for private equity and venture capital players. This is the case in the most developed of economies and in those that are developing, i.e. Turkey and the Balkan region.
One way to reduce risk is to allow co-investors into your deals.
The benefits of co-investing into deals are obvious: sharing of due diligence work, resources, best-practices and know-how. The ultimate goal is to be able to share the risk of investment.
As appealing as it may seem, there are several other factors that I believe PE and VC firms must be mindful of when experimenting with co-investment opportunities. First and foremost, the identification of a potential co-investor will most probably divert more resources from your firm that what is often initially planned. Almost everyone in the PE and VC community has ample experience in trying to identify fresh funding for new companies. This is primarily an exercise in exactly that: identifying new sources of funding for your deal. It can be challenging to find the right investor for the right deal.
Size of the deal matters when considering co-investment partners. All private equity and venture capital firms have target investment sizes and other criteria that their deals must meet. It is often difficult to compress and balance all of the criteria of multiple investors into a successful deal. The chance of the deal falling apart also increases as the number of co-investors increase.
Beware of the ego. For some reason the ego problem is much more prevalent in private equity and venture capital firms in developing nations than they are in more developed economies. That is simply what I’ve noticed over the years – however other investors may certainly have different experiences with competing egos. After all, it is human nature to try to become the hero – it just becomes rather complicated when we are dealing with other people’s money!
All PE and VC firms have set agendas and strategies for when they enter deals. Co-investment may produce tremendous conflicts of interest from the moment of closing until the actual exit. Each investor will have varying ideas and demands on how to grow their portfolio companies (organic or inorganic), who will manage the growth, when to consider an exit, what the exit strategy will be, etc… A refined definition, understanding, and agreement of all voting rights is an absolute must when going into a co-investment deal.
Although co-investment may sound like a good idea at the outset, it can turn into an unproductive deal at the end of the exercise. This is especially the case when working in developing nations. Investors must be ready for a bumpy ride.
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