A GP offers a large LP either a management fee cut or priority on co-investments. Discount both to today and the answer turns on take-up, returns and deal selection.
Put both on the same footing: the present value of the fee discount against the present value of the fee and carry saved on the co-investments the LP will actually do. On a 100 commitment, a 25 basis point discount is worth 1.19 in present value after carry; co-investment rights are worth 4.33 if the GP offers 50 and the LP takes 60 per cent of it. The rights win above a take-up of 16.5 per cent, about 8.2 invested, and lose to the discount if the co-investments are 0.3x worse than the fund's deals.
Worked in full in The Co-Investment Practitioner by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
The trade is a common one in a fundraise. A large LP asks for better terms; the GP offers either a cut in the management fee or priority on co-investment, which costs the GP nothing in fees today. The discount is certain and small. The rights are uncertain and potentially large. Both can be priced in one sheet.
| Input | Value |
|---|---|
| LP commitment | 100 |
| Fund management fee / carried interest | 2% / 20% |
| Preferred return, full catch-up | 8% |
| Fee base after the investment period, share of commitment | 60% |
| Offer A: fee discount for the life of the fund | 25 bps |
| Offer B: co-investment offered over five years, share of commitment | 50% |
| Share of offered deals the LP takes up | 60% |
| Gross multiple, fund deals and co-investments alike | 2.0x |
| Hold per deal, years | 5 |
| LP's legal and diligence cost per co-investment | 1.0% |
| Discount rate | 8% |
Co-investments are made at no fee and no carry, the usual terms for a fund's own LPs. The saving is measured against the alternative of putting the same money into the fund on standard terms. That is the right comparison: the co-investment capital is extra money, and its alternative is another fund commitment, not cash.
Years 1 to 5: 0.25% × 100 = 0.25 a year. Years 6 to 10: 0.25% × 60 = 0.15 a year.
Fees saved: undiscounted 2.00; present value at 8% = 1.41
Less the GP's carry on the extra profit: 20% × 2.00 = 0.40, present value 0.22; net 1.60 undiscounted, 1.19 in present value
Eight commitment-years of fee base times 25 basis points. Lower fees raise the LP's profit in the fund, and at 2.0x gross, past the catch-up, the GP takes 20 per cent of it as carry, paid as the deals exit in years 6 to 10; the LP keeps 80 per cent. In Excel, with the yearly savings in B2:B11: =NPV(8%,B2:B11), less the carry flows discounted the same way.
Fees avoided = 2% × 5 years = 0.10 per unit
Carry avoided = 20% × (2.0 − 1 − 0.10) = 0.18 per unit
At 2.0x gross the 8 per cent preferred return, 1.4693x over five years, is cleared and the catch-up complete, so carry is a full 20 per cent of profit after fees. The fund nets 1.72x; the co-investment nets 2.0x less its own costs. The saving is 0.28 per unit.
Co-invested = 100 × 50% offered × 60% taken = 30.0, or 6.0 a year
Saving = 30.0 × 0.28 = 8.40 undiscounted, received at exit in years 6 to 10
Discounted at 8 per cent, the saving is worth 4.57. The LP's own deal costs, 1.0 per cent paid at entry, are worth 0.24. Net present value 4.33, about 3.6 times the discount.
Each co-invested unit is worth 4.33 ÷ 30.0 in present value, so the rights match the discount at 1.19 of value, which needs 8.2 of co-investment: a take-up of 16.5 per cent of what the GP offers. Below that, the discount is worth more.
| Take-up | Co-invested | Value of rights |
|---|---|---|
| 0% | 0 | 0.00 |
| 20% | 10 | 1.44 |
| 40% | 20 | 2.88 |
| 60% | 30 | 4.33 |
| 100% | 50 | 7.21 |
| Gross multiple | Saving per unit | Value of rights at 60% take-up |
|---|---|---|
| 1.3x | 0.10 | 1.39 |
| 1.6x | 0.13 | 1.89 |
| 2.0x | 0.28 | 4.33 |
| 2.5x | 0.38 | 5.96 |
The two offers behave differently in a bad vintage. The fee discount pays regardless of performance. The co-investment saving falls with returns because carry, which is nearly two thirds of it at 2.0x, disappears below the hurdle: at 1.3x only the fees are saved and the rights are worth 1.39, just under the discount, which keeps its full 1.41 because a fund below its hurdle pays no carry. At 2.0x a 10 basis point discount is worth 0.48 after carry and a 50 basis point one 2.38, so a GP offering a deep cut is offering more than a modest co-investment allocation.
The fee discount is a contract term. Co-investment rights rarely are: side letters usually grant priority or notice, not an allocation. A take-up of 60 per cent of a 50 per cent offer assumes the GP actually brings that flow and the LP has the team, the speed and the capital to say yes inside the window.
Valuing the rights at the fee and carry saved on deals of fund quality. The deals offered for co-investment are the ones the GP chose to syndicate, and an LP that takes them without selecting well may get the larger or harder half. If the co-investments return 1.7x gross against the fund's 2.0x, the LP's 1.7x without fees trails the fund's 1.72x net, an advantage of minus 0.02 per unit, and the rights are worth minus 0.57. A 0.3x selection gap turns a 4.33 gain into a loss. The same break-even logic, deal by deal, is in how much worse co-investment deals can be and still beat the fund; how much deal flow a programme needs to select from is in this companion piece.
Take the rights if you will co-invest more than about a sixth of what the GP offers and can select as well as the GP: here they are worth 4.33 against 1.19. Take the discount if the programme is not yet staffed, if the GP's co-investment flow is thin, or if the vintage looks weak. The Co-Investment Practitioner covers sourcing, underwriting and building the programme that makes the rights worth having, and the free workbook for the book prices what co-investment terms cost and save.
Multiply it by the fee base over the fund's life and discount. On a 100 commitment with fees on commitment for five years and on 60 per cent of it for five more, 25 basis points saves 0.25 then 0.15 a year: 2.00 undiscounted, 1.41 in present value at 8 per cent. At 2.0x gross the GP takes 20 per cent of the extra profit as carry, so the LP keeps 1.60, or 1.19 in present value.
On an illustrative deal returning 2.0x gross over five years against a 2 and 20 fund, the LP avoids 0.10 of fees and 0.18 of carry per unit, 0.28 in all, before its own deal costs. At 1.3x the carry saving disappears below the 8 per cent hurdle and only the 0.10 of fees remains.
Rarely. Side letters typically give priority, notice or a right of first look, not a fixed allocation. The value depends on the flow the GP brings and the share the LP can execute: in the illustrative case the rights beat a 25 basis point discount only above 16.5 per cent take-up.
This article is one calculation from The Co-Investment Practitioner. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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