Why co-investment strategies of family offices may have hidden risks
Co-investment is a strategy increasingly favoured by family offices, involving joint deals that unite multiple families for collective investments, participation alongside private equity funds without direct commitments, or collaboration with another family on business ventures. However, experts caution that this approach carries inherent risks and may not be suitable for everyone.
Hamilton Lane
“Most of the family offices that we deal with will not choose to do co-investments, because they understand that it's a completely different underwriting game,” said Collwyn Tan, co-head of Asia Investments at Hamilton Lane.
To navigate co-investments effectively, it is essential to have a dedicated team that collaborates closely with the general partner (GP). Tan emphasised that simply participating in syndications - where a GP leads a large deal and limited partners (LPs) contribute a few million - does not suffice.
“This method is the least effective, as it restricts the LP’s engagement and insight into market dynamics,” Tan explained.
Over recent years, co-investment has gained popularity among LPs. According to Pitchbook, GPs, particularly those in the lower middle market, use co-investments as a way to establish and solidify relationships with LPs—an otherwise challenging feat given the lethargic fundraising environment. Notably, PitchBook data reveals that 86% of PE deals involving co-investors in 2023 have fallen below the $500 million mark.
Source:Pitchbook
Despite this trend, challenges remain.
Tan noted that many family offices lack scale to co-underwrite investments with GPs and often face deals that force them to make compromises.
“If a family office only encounters a couple of deals per year, the pressure to say yes to every opportunity can create further anxiety about missing out on prospects. These psychological and structural challenges can hinder effective investment strategies for family offices,” Tan said.
Buyouts are the most common and mature co-investment strategy, targeting established companies with stable cash flows and offering a predictable risk-return profile. These deals often involve larger sums, attracting institutional co-investors.
In buyout co-investments, family offices may experience what’s known as the J-curve, where initial investments show negative returns due to upfront costs before generating positive cash flow. This can lead to temporary markdowns in capital statements.
“These markdowns, though often temporary, can be challenging for family offices, as they may not immediately see the potential for long-term gains, especially in volatile market conditions,” Tan added.
THE MECHANICS OF IT
Due diligence is critical in co-investments, as investors are exposed to specific risks without the diversification typically offered by funds.
“Our recommendation—and something we adhere to when conducting due diligence—is to avoid investments with too many layers,” said Manish Tibrewal, co-founder of Farro Capital.
Farro Capital
“These structures distance you from the asset, making it harder to manage or oversee directly,” he added.
For family offices with smaller check sizes, Farro Capital recommends the SPV route.
“Some companies do not want smaller cheque sizes on their cap table, and in such cases, SPV is created to pool funds into a larger, more acceptable entity,” Tibrewal said.
Ho Han Ming, partner at law firm Reed Smith, highlighted that exit strategy conflicts tend to arise among co-investors, especially with differing exit timelines. Reputational and geopolitical risks can also intensify, particularly in sensitive sectors or less favourable jurisdictions.
Reed Smith
“It is helpful to have a clear exit strategy from the outset and thorough due diligence to manage reputational risk, especially when co-investing in sectors with heightened scrutiny including technology and healthcare space,” he noted.
Ho also recommended that family offices safeguard their interests as direct investors by securing minority protection rights, ensuring transparent reporting, and establishing deadlock resolution mechanisms and pre-emptive buyout clauses.
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POPULAR INVESTMENTS
Real estate investment remains a popular choice for co-investment, according to Tibrewal. However, many families are also drawn to what’s currently popular or glamorous.
“Right now, it's artificial intelligence. Previously, it was e-commerce,” he said.
Farro Capital also observes that most of the interest in co-investment is in growth and late-stage investments, where check sizes are much larger. This makes them more attractive and provides access to bigger opportunities.
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Hamilton Lane particularly favours mature deals and small to mid-sized buyouts. “We believe this segment offers the best market opportunities,” Tan noted.