Co-investment: Partners in time

HarbourVest Partners' fastest due diligence for a successful co-investment to date was achieved in five days, while its longest took more than a year. That one firm – with substantial co-investment resources at its disposal – can see such a discrepancy in this process says everything about the breadth and complexity of the variables involved.

In the fast scenario, HarbourVest received a call from a GP on a Monday asking for a commitment regarding an enterprise data business by Friday. It was a relationship more than two decades in the making, with several fund positions and co-investments along the way. Both GP and LP commanded substantial expertise in the target sector.

On that Monday, HarbourVest's top questions were floated over the phone and anticipated by the fund manager, which had already prepared the appropriate response materials. Reference calls were made on Tuesday. By Wednesday, the first investor commitment (IC) was convened. Findings from the IC were considered on Thursday, and 24 hours later, the firm had agreed to sign an equity commitment letter.

The slow scenario, involving a European chemical business, was conducted with no stop date. The vendor was not running a full-scale, competitive process and consequently took its time answering diligence queries. Relationships facilitated the proprietary access but, unlike the IT investment, did little to speed things up. Ample deal assessment capacity also proved to be a muted factor. HarbourVest has more than 40 dedicated co-investment professionals who field 2-3 opportunities every working day.

Resource rich

The advantage of having experienced staff that can take such a high volume of calls and run an efficient early screening process, however, cannot be discounted, even in protracted diligence situations. Competence in this area is critical because the most important moment in co-investment due diligence is arguably the initial, binary decision about committing any resources whatsoever must be made. Confidence in the GP, familiarity with the target industry, and the particulars of deal negotiations will all inform the approach, but the ability to effectively calibrate diligence strategy around these considerations hinges on having sharp eyes on the front lines.

"At any time, the attractiveness of a deal can change as you gain incremental information. Before we get there though, we need to have the ability to assess a deal without the benefit of comprehensive information when a GP rings us with a new opportunity," says Kelvin Yap, a managing director at HarbourVest. "We know the pricing that GPs are paying in almost any quarter for a given sector in any given geography, and that is very powerful information. There is also an element of operating through experience as opposed to spreadsheets, and in my mind, you can't replace that with a process."

These instincts are all the more essential for the likes of corporates, family offices, and development financial institutions, which typically take at least two months to confirm a deal due to limited assessment bandwidth, regardless of the clarity of their co-investment mandates. In the end, due diligence provides indicative rather than definitive answers, so the risk of committing resources to a doomed deal is always part of the equation. But many of these firms find that adding rigor to the initial screening process not only reduces that risk, it better positions them for future deals. 

There are a number of ways to make this work, including putting a strong emphasis on improving efficiency through indexation strategies. Under this model, an LP with a large portfolio of fund managers automatically agrees to co-invest opportunities under certain circumstances but risk is managed by placing a low cap on possible allocations. In another approach, Jebsen Capital, the investment arm of Hong Kong conglomerate Jebsen Group, stresses patience.

The firm, which has expertise in consumer products, sees co-investment in part as a way to explore unfamiliar sectors such as healthcare. Nevertheless, Thomas Wetzer, a senior portfolio manager at Jebsen Capital, recently told the Hong Kong Private Equity & Venture Capital Association's Asia Forum that although he has no dedicated co-investment personnel, full due diligence must be conducted on all deal opportunities, even if an experienced GP has already done the legwork.

"You want to have done your own due diligence just to make sure that there won't be any conflict of interest. You have looked at this investment in a way that you want to look at it and understood it in a way that you want to understand it," Wetzer said, noting the importance of confronting pressures around scheduling and capacity with a certain realism. "It may take more time, but in the end, you always have to be prepared not to sign a deal no matter how much money, time, and resources you put into it."

Time pressures

Perhaps the most important risk to the patient approach is the demand for time and resources that it can place on GPs engaged in negotiating with vendors on the fly and unable to pause the process to check with a partner. This can be mitigated to some extent by working exclusively with core portfolio GPs, thereby expediating the validation of existing diligence work. But for firms such as Quilvest Private Equity, a century-old family office that professionalized its co-investment approach when it started managing third-party capital in 2002, building up in-house diligence capacity delivers long-term advantages with a range of co-invest partners. 

"It all depends on how much of their time you're wasting, because if you go through a diligence process and your own IC process is slow and prolonged, you're going to end up hurting the relationship more because you couldn't yourself figure out your own process," says Maninder Saluja, a partner and head of funds and co-investment at Quilvest. "I think that's what comes across sometimes [with GPs]."

Ultimately, the best approach to sparing GPs the runaround on co-investment due diligence with limited resources comes back to the strict screening espoused by more heavily resourced firms such as HarbourVest. But while this tactic may result in strings of negative responses, it doesn't necessarily have to translate into a series of frustrations, especially when the end-game is to forge long-term networks. 

"If you've passed on three co-investments because it just didn't fit your portfolio construct, as long as you're supportive of what they [the GPs] are doing, and you go back into the next fund, I don't think anybody minds," Saluja adds. "It's not like they're going to be less likely to spend time on a deal with you if you pass three times."

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• Topics
• LPs
• GPs
• Asia
• Co-investment
• HarbourVest Partners
• Direct investment