A co-investment sold as no fee, no carry still pays the fees the sponsor charges the portfolio company, and unlike the fund's investors the co-investor gets none of them back.
A co-investor on no-fee, no-carry terms still bears its share of every fee the sponsor charges the portfolio company, and unlike the fund's investors it gets no management fee offset to recover it. On an illustrative 400.0 buyout with a 1 per cent transaction fee and 1.0 a year of monitoring fees, a 10 per cent co-investor's multiple falls from 2.00x to 1.93x and its IRR by 79 basis points, the same as paying a management fee of about 1.03 per cent a year.
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 →
Co-investments are marketed on what they do not charge. What they do charge is buried one level down, in the closing funds flow and the monitoring agreement between the sponsor's management company and the portfolio company. Those fees are paid by the company, so every shareholder bears them in proportion to ownership. The fund's investors are made whole by the offset in their limited partnership agreement. The co-investor sits beside the fund with no such clause unless it negotiated one.
| Input | Value |
|---|---|
| Enterprise value at entry | 400.0 |
| Debt | 200.0 |
| Transaction fee to the sponsor, 1% of EV | 4.0 |
| Equity required, including the fee | 204.0 |
| Monitoring fee a year (2.5% of 40.0 EBITDA) | 1.0 |
| Hold | 5 years |
| Interest rate on debt the fees could have repaid | 8% |
| Exit equity before monitoring fees | 400.0 |
| Co-investor's share of the equity | 10% |
Without any fees the deal is a clean 2.00x: 200.0 of equity becomes 400.0. That is the return the co-investment was underwritten on.
Cost at closing = share × transaction fee
Cost at exit = share × Σ monitoring feet × (1 + r)(n − t)
In Excel, the exit cost: =Share*FV(Debt_Rate,Years,-Monitoring_Fee)
At closing. The 4.0 fee is a use of funds, paid by the equity. The co-investor writes 20.40 instead of 20.00 for the same 10 per cent: 0.40 that buys nothing.
During the hold. Five monitoring payments of 1.0 leave the company as cash that would otherwise have repaid 8 per cent debt. By exit they have cost 5.87 of equity, 5.0 of fees plus 0.87 of interest. The co-investor's share is 0.59.
Result. The co-investor pays 20.40 and receives 10 per cent of 400.0 − 5.87, which is 39.41: 1.93x and an IRR of 14.08 per cent, against 2.00x and 14.87 per cent. The total cost is 0.40 + 0.59 = 0.99, 4.9 per cent of a 20.0 cheque. Solving for the annual fee on cost that produces the same IRR gives 1.03 per cent a year.
| Case | Paid | Received | Multiple | IRR |
|---|---|---|---|---|
| No company fees | 20.00 | 40.00 | 2.00x | 14.87% |
| Transaction fee only | 20.40 | 40.00 | 1.96x | 14.42% |
| Transaction and monitoring fees | 20.40 | 39.41 | 1.93x | 14.08% |
| Plus acceleration at exit | 20.40 | 38.91 | 1.91x | 13.79% |
| Fees shared pro rata with the co-investor | 20.00 | 39.91 | 2.00x | 14.92% |
The acceleration row assumes a ten-year monitoring agreement terminated at exit with five years of fees, 5.0 undiscounted, paid in a lump sum. It lifts the IRR cost to 108 basis points, equivalent to a 1.41 per cent annual fee. The last row is the remedy: the co-investor receives 10 per cent of each fee as it is paid, 0.40 at closing and 0.10 a year. Its return is restored to slightly above the no-fee case, because the rebates arrive in cash while the cost is only felt at exit.
The fund owns 90 per cent and its share of the fees is 8.10. With a 100 per cent offset, all of it comes back as a lower management fee, and the fund's investors bear only the 0.78 of interest the cash would have saved: 0.42 per cent of the fund's 183.6 cheque. The co-investor bears 0.99 on 20.40, 4.8 per cent. Same company, same fees, and a cost eleven times higher per unit of capital for the investor whose terms said no fee.
The offset cuts both ways for the sponsor. With a full offset, the sponsor collects nothing net from fund investors, so the only fee income it keeps from the company is the co-investors' share. That is a reason to ask about fee sharing, not a reason to assume bad faith.
| Exit equity | Gross multiple | IRR, no fees | IRR, with fees | Cost |
|---|---|---|---|---|
| 300.0 | 1.50x | 8.45% | 7.59% | 85 bp |
| 400.0 | 2.00x | 14.87% | 14.08% | 79 bp |
| 600.0 | 3.00x | 24.57% | 23.84% | 74 bp |
The cost is fixed in money, so it weighs most on the weakest deals: 85 basis points at 1.50x against 74 at 3.00x. Unlike carried interest, it does not disappear when the deal disappoints.
Ask for the closing funds flow and the monitoring agreement before signing, then price your share of every fee with no offset. On this case it is 0.99, 79 basis points of IRR, and a pro rata fee share removes almost all of it. The working documents in the free companion files for this book include a page on the terms that move the return. For how much fee saving a co-investment can afford to lose, see how much worse co-investment deals can be, and for the fund side of the offset, how to recompute a management fee after offsets.
Usually not, because they pay no management fee to offset against. Fund investors with a 100 per cent offset recover their share of transaction and monitoring fees through a lower management fee. A co-investor on no-fee terms bears its share in full unless the documents give it a pro rata share of the fees. In the illustrative case that costs 0.99 on a 20.0 cheque.
A clause under which the remaining years of a monitoring agreement become payable in a lump sum when the company is sold or listed. On an illustrative 1.0 a year agreement with five years left at exit, acceleration takes another 5.0 from exit equity, and the co-investor's IRR cost rises from 79 to 108 basis points. Practices of this kind have drawn regulatory scrutiny, and many sponsors have dropped them.
By negotiating a pro rata share of every fee the sponsor or its affiliates charge the company, or an equivalent offset. In the illustrative case, receiving 10 per cent of the 4.0 transaction fee at closing and of each 1.0 monitoring fee restores the co-investment to roughly its no-fee return, 14.92 per cent against 14.87.
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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