M. Machua Millett
Co-Investing can be a great way to maximize investment leverage and return, but it can also exacerbate risk exposures when things do not work out as planned for all co-investors. As family offices increasingly create syndicates and enter into co-investments, it is important that they understand the potential benefits and risks, as well as best practices around structure, legal arrangements, risk management, and insurance. Experienced legal and risk management practitioners shared real-life successes and horror stories, as well as lessons learned, and trends seen in the area of family office co-investment.
- Shareholder Rights: The Co-investor rights should be negotiated/taken into consideration in a Shareholder´s agreement between the Co-investment vehicle and the Lead Investor/Sponsor´s main fund. This agreement should include tag-along rights (allowing minority investors to participate on a pro-rata basis in any sale of securities by the controlling shareholder), drag along rights (requiring minority shareholders to sell their interest at the same time and on the same terms as controlling shareholder), pre-emptive rights on future sales (both at the co-investment vehicle level, operating company level, and subsidiary level). In essence, it is key to clarify what will happen when any shareholder sells.
- Management Fees and Carried Interest: The larger PE deals have no carry, while the smaller PE and most RE deals do have them.
- Expenses: It is critical to clarify beforehand if the deal expenses are included in the investor´s aggregate commitment, if expenses are capped and how will the expenses will take care of if the deal is broken.
- Closing Conditions: Typical closing conditions involve a Material Adverse Effects (MAE) Clause that leads to a fundamental change in the economics of the target (even though Courts are very tough on what constitutes MAE) add opt-out clauses if there are changes in Debt-Equity ratios, credit arrangements, or the deal does not close by a certain date.
- Sponsor Concerns: These typically include the need for sponsors to know if the commitment is there (as speed is critical), the allocation of investment opportunities, and who will pick up the deal expenses if the deal is broken (the typical way is to use the expected equity commitments.)
- Family Office as Sponsor: This is a growing trend, and there are additional complications/issues to consider in this case, including information sharing, expenses, and fiduciary duties.
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