Every co-investment carries a fixed bill for diligence, legal work, staff time and monitoring: the cheque size at which the fee and carry saving covers it, and the size at which it stops mattering.
The minimum cheque is the present value of the deal's fixed costs divided by the present value of the fee and carry saving per unit invested. With an illustrative saving of 0.36x at exit, 0.234 per unit today, and 0.52 of costs per deal in present value, break-even is a cheque of 2.21. Below that the co-investment costs more to execute than it saves. To keep three quarters of the saving, the cheque needs to be 8.8.
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 case for co-investing is that the money pays no management fee and no carry. The saving scales with the cheque. The cost of doing the deal does not: the same diligence, the same legal review and the same committee paper are needed for 2 as for 50. Somewhere between the two the deal stops being worth the work.
| Input | Value |
|---|---|
| Gross multiple of the deal | 2.00x |
| Net multiple of the same deal through the fund | 1.64x |
| Holding period | 5 years |
| Discount rate | 9% |
| External due diligence and advisers, per deal | 0.20 |
| Legal review, per deal | 0.10 |
| Internal staff time to review and approve | 0.12 |
| Monitoring, per year | 0.025 |
The costs are illustrative and assume the LP bears its own diligence. Where the sponsor's work is shared, external costs fall, but internal time and monitoring remain.
Step 1: the saving per unit invested. The co-investor keeps the gross multiple, 2.00x, against 1.64x through the fund: 0.36x per unit, received at exit. Discounted five years at 9 per cent (factor 0.6499):
PV saving = 0.36 × 0.6499 = 0.234 per unit
Step 2: the cost per deal. 0.20 + 0.10 + 0.12 = 0.42 at entry, plus 0.025 a year of monitoring. The annuity factor for five years at 9 per cent is 3.8897, so monitoring is worth 0.097 today.
PV cost = 0.42 + 0.097 = 0.52 per deal
Step 3: the break-even cheque.
Minimum cheque = 0.52 ÷ 0.234 = 2.21
In Excel: =(Upfront+Monitor*(1-(1+r)^-n)/r)/((Gross-Net)*(1+r)^-n). For a policy threshold where costs may take at most a quarter of the saving, divide by 25 per cent of the PV saving instead: 8.8.
| Cheque | PV saving | PV cost | Net | Costs as share of saving | Net saving, x |
|---|---|---|---|---|---|
| 1.0 | 0.23 | 0.52 | −0.28 | 221% | −0.436x |
| 2.0 | 0.47 | 0.52 | −0.05 | 111% | −0.038x |
| 5.0 | 1.17 | 0.52 | 0.65 | 44% | 0.201x |
| 10.0 | 2.34 | 0.52 | 1.82 | 22% | 0.280x |
| 20.0 | 4.68 | 0.52 | 4.16 | 11% | 0.320x |
| 50.0 | 11.70 | 0.52 | 11.18 | 4% | 0.344x |
At a cheque of 1.0 the deal destroys 0.436x of value against simply owning it through the fund: the saving is real, but the cost of capturing it is more than twice as large. At 10.0 the co-investor keeps 0.280x of the 0.36x headline. Only around 50.0 does the headline saving become a fair description of what is earned.
The saving per unit is the fund's gross-to-net spread on this deal, so the minimum cheque moves with it.
| Gross and net multiple | Saving at exit | Break-even cheque | Costs at 25% of saving |
|---|---|---|---|
| 1.80x gross, 1.50x net | 0.30x | 2.65 | 10.6 |
| 2.00x gross, 1.64x net | 0.36x | 2.21 | 8.8 |
| 2.50x gross, 1.98x net | 0.52x | 1.53 | 6.1 |
A weaker deal saves less, because carry is lower when gains are lower, so the minimum rises exactly when the deal is least attractive.
This is a floor on cost grounds only. It assumes the co-investment performs like the fund's other deals. If co-investments are on average weaker, the gap measured in how much worse co-investment deals can be and still beat the fund comes out of the same 0.36x.
Many co-investors do not commission full external diligence. They read the sponsor's reports, take reliance letters where available and spend their own money only on the points that worry them. Cut external costs from 0.20 to 0.05 and keep everything else:
PV cost = 0.05 + 0.10 + 0.12 + 0.097 = 0.37
Break-even cheque = 0.37 ÷ 0.234 = 1.57, and the 25 per cent threshold falls to 6.3
Lighter diligence lowers the floor, but by less than a third, because legal review, internal time and monitoring do not shrink with it. It also moves the risk from the cost line to the deal: relying on the sponsor's work is relying on the party selling the allocation.
Minimum cheque = PV of per-deal costs ÷ PV of the saving per unit: 0.52 ÷ 0.234 = 2.21. Set the policy minimum well above it, at 8.8 if costs may take a quarter of the saving. The programme-level version of the same arithmetic is in what a co-investment programme actually saves, and the reserve arithmetic for the same deals is in the free workbook for this book.
External due diligence and advisers, legal review of the documents, internal staff time to run the review and committee, and monitoring for the life of the deal. In the illustrative case 0.20, 0.10 and 0.12 at entry plus 0.025 a year for five years, 0.52 in present value terms, whatever the size of the cheque.
Because the costs are paid at entry and the saving arrives at exit. A 0.36x saving on a five-year deal is worth 0.234 per unit today at 9 per cent. Ignoring timing puts break-even at a cheque of 1.51 instead of 2.21, understating the minimum by about a third.
Large enough that fixed costs take a small share of the saving, small enough to diversify. In the illustrative case costs take 44 per cent of the saving at a cheque of 5.0, 22 per cent at 10.0 and 4 per cent at 50.0; 8.8 is where they fall to a quarter.
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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