When Avigo Capital, an Indian mid-market private equity firm, recently concluded an agreement to co-invest $20 million in AMR Constructions, it took them only less than a month to wire the money to the company’s bank account. The financial and legal due diligence was done quickly, despite the presence of the new investors in the round. What really helped the speedy execution of the deal was the fact that the co-investors were the investors or limited partners (LPs) in Avigo itself. Macquarie Asia Pacific and Hong Kong-based Squadron Capital took a direct exposure in AMR along with Avigo, which is an indicator of a growing trend of LPs tagging along with their General Partners (GPs) in investments.
Apart from a timely execution of the deal, there are many more advantages of doing co-investment deals with the LPs. “It de-risks the fund exposure level to an individual company and provides the ability to drive the deal on the GP’s timeframe and terms,” said S. Harikrishnan, General Partner of Avigo Capital.
This is not the first time that Avigo Capital has got its LPs to co-invest along with itself in making direct investments into companies. Metmin, another LP, and Macquarie invested, along with the private equity fund, into material handling company Tecpro Systems.
From an LP perspective too, such co-investments make for a good deal as they can piggyback the GP’s knowledge and the due diligence process of the industry and the company, and can also pick and choose the company which he/she wants to invest in, to maximise the return.
“The rationale behind co-investing with GPs on direct investments is twofold. Firstly, you get selective additional exposure to potentially high quality companies. And secondly, it makes more economic sense if we get preferential terms for fee & carry,” says Anand Prasanna, Investment Director, Squadron Capital Advisors Ltd, a Hong Kong-based fund-of-funds in India which has multiple relationships in India.
In the context of getting additional exposure to potentially high quality companies, there are even situations when you tend to make more by directly investing into a company than an LP can make on a private portfolio. A case in point is the LPs’ investment in Tecpro Systems.
According to VCCircle estimates, Metmin Investments made more than 7x returns by part-exiting its five-year-old investment in PE-backed Tecpro Systems in its IPO last year (based on the upper end of the price band of Rs 340-355). On an average, an LP tends to make up to 4x and that too on PE funds, which deliver up to 25 per cent IRR in the best cases possible.
Apart from getting an exposure to high quality companies, what really makes the thesis for doing co-investments so attractive is the economics involved. LPs tend to get extra gains for their portfolio as they get more preferential management fee and carry for those deals. In a typical LP-GP relationship, General Partners are entitled to a 2:20 fee structure, but in case of such deals, either the general fee structure is completely waived or there is a significant discount to the upside, which gets doled out to the GPs. According to an LP who did not wish to be quoted, different funds follow different structures – with significant discounts like 1:10 to no fee at all, in most cases.
So, are LPs eating into GPs’ lunch? If looked at from a GP perspective, perhaps yes. The LPs, riding on the knowledge base and due diligence process of the GPs, get an exposure to a potentially high quality company without paying a management fee in most cases and also get a better yield on their investments. More often than not, it turns out that the GP behaves as a banker without a fee in these cases.
LPs, however, differ in this respect. “On the contrary, LPs are helping GPs through co-investments. Co-investing with LPs gives GPs the flexibility to execute larger deals, which they don’t want to pass on or share with a competitor due to deal dynamics. LPs are also willing to share some economics which other PE funds will not be willing to do,” adds Prasanna.
Recently, Baring Private Equity Partners, a leading Indian private equity firm with about $1 billion under management, invested $90 million into Cethar Vessels Ltd, a Tiruchirappalli-based power equipment manufacturer. Siguler Guff India Advisors Pvt Ltd, the India arm of a leading global fund-of-funds and an investor in BPEP India, also co-invested along with Baring, in what marked the largest deal coming from the private equity firm. For mid-sized private equity firms, there is also a limit on how much they can expose themselves to a particular investment.
“Co-investing with the LPs enables us to do a larger deal and also have a larger role within the board of the investee company by representing all the investors,” Hariskrishnan adds. “Also, there are times when we have better expertise in certain sectors and we can add more value to the table,” said the LP who did not wish to be quoted.
Earlier, Evolvence Capital & SEDCO invested along with UTI Ventures (now Ascent Capital) in Chennai Construction Company Ltd. Also, Banyan Tree Growth Capital, a Mauritius-based mezzanine fund, has previously co-invested with its investor – Dutch entrepreneurial development bank FMO – in synthetic rope manufacturer Axiom Impex Ltd. The duo also invested in Kalpena Industries, a manufacturer of PVC compounds.
In no case would a PE firm want its deal to go to competition for want of more dollars to execute a deal or lose it, in the worst case. “I would always prefer my LP than a competition fund,” said a private equity investor. It often turns out to be a win-win situation for both the parties.