Co-investment vehicles (CIVs) are increasingly used by venture capital (VC) funds to allow certain limited partners (LPs) to make additional investments alongside the main fund. While these vehicles can offer significant benefits to both fund managers and LPs, establishing one requires careful planning and structuring. Below are some of the key considerations for setting up a co-investment vehicle.

Purpose and Strategy

The first step is to define the purpose and investment strategy of the co-investment vehicle. Typically, co-investment vehicles are used for specific deals where the main fund’s allocation is capped, or the fund seeks to offer its LPs access to high-quality opportunities. Clearly articulating the investment scope and strategy ensures alignment among all parties and avoids potential conflicts.

A well-defined purpose helps avoid misalignment between the main fund and the co-investment vehicle. For example, if the vehicle targets specific sectors, geographies or targets investment in a particular portfolio company, this should be clearly outlined in the CIV term sheet and corresponding governing agreement of the CIV and communicated to all participating LPs. Additionally, the co-investment vehicle should remain complementary to the main fund’s objectives, ensuring synergy rather than competition.

Governance and Structure

Deciding on the governance structure of the co-investment vehicle (CIV) is critical. Most co-investment vehicles are set up as limited partnerships or limited liability companies (LLCs). The chosen structure should align with the investment strategy and the needs of the LPs.

Key Structural Considerations:

• Legal Entity: The CIV is typically structured as a legal entity separate from the main fund in the form of an LLC or a limited partnership which shares its management with the main fund.

• Decision-Making: Governance can be centralized with the fund manager or involve a joint committee that includes representatives from LPs. While the fund manager typically retains operational control, significant decisions — such as major follow-on investments or exits — typically require LP approval.

• Roles and Responsibilities: Clearly defined roles for the general partner (GP) and LPs are crucial. GPs generally handle day-to-day operations, while LPs of the CIV have limited rights, such as veto powers for specific transactions.

• Dispute Resolution Mechanisms: Provisions for resolving disagreements, such as arbitration clauses or predefined protocols, should be included to ensure smooth operations. This reduces potential delays caused by deadlocks.

Establishing transparent governance structures not only fosters trust but also minimizes the risk of disputes or misaligned expectations.

Fees and Economics

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Fee structures for co-investment vehicles differ from those of the main fund. Often, fund managers charge reduced or no management fees and carry interest to make co-investments more attractive to LPs. However, it’s essential to strike a balance that incentivizes all stakeholders.

Detailed Fee Considerations:

• Management Fees: While some CIVs charge no management fees, others may impose modest fees to cover operational and administrative costs. For instance, a fee ranging from 0.5% to 1% may be levied to ensure the vehicle operates efficiently without overburdening LPs.

• Carried Interest (Carry): While most CIVs might not impose Carry at all, Carry for CIVs is otherwise often lower than the traditional 20% charged by the main fund. For instance, a carry rate of 5% to 10% is otherwise common. This reduced rate makes the vehicle more attractive to LPs while still compensating the fund manager for the additional workload.

• Expense Allocation: Legal, due diligence, and other operational expenses of the CIV should be clearly defined and allocated fairly among LPs. Typically, the fund manager is not responsible for CIV expenses and all CIV expenses are rather passed through to the LPs participating in the CIV.

By structuring fees carefully, fund managers can create a compelling value proposition for LPs while ensuring the vehicle’s sustainability.

Exit Strategies

Given the illiquid nature of private investments, exit strategies for co-investment vehicles must be clearly defined. These should align with the main fund’s exit plans to avoid misalignment.

A robust exit plan ensures that all stakeholders have clarity on the investment horizon and potential liquidity events. For example:

• Defined Exit Timeline: The CIV should specify its anticipated investment duration, which typically aligns with the lifecycle of the main fund.

• Mechanisms for Liquidity: Provisions for secondary transactions can offer LPs an opportunity to exit early if necessary. This can include buyouts by other LPs or third-party investors.

• Alignment with the Main Fund: Exit strategies should be consistent with the main fund’s approach to avoid potential conflicts. For instance, simultaneous exits for both the fund and the CIV can streamline processes and optimize returns.

Well-structured exit strategies not only provide clarity for LPs but also enhance the overall appeal of the co-investment vehicle.