Covid-19 and Co-Investments
How LPs can play a crucial role for portfolio companies
As Covid-19 continues to disrupt our daily lives, uncertainty for all people in its way looms. This quick note addresses how LPs, particularly those allocating to emerging managers, have the opportunity to navigate through these tough times while adding value to their current and prospective GPs. When referring to LPs, I mainly refer to HNWI/FOs as most institutional investors aren’t equipped to doing co-investments.
As asset managers scramble to quantify how Covid will impact global growth and where to shift assets in the midst of the turmoil, one thing becomes clear — those who can take an active investment approach will bear fruit when this is all over. This is particularly true for LPs who don’t have tight allocation guidelines and who don’t have to follow traditional diversification models. Those funds that have an institutional LP base are at the mercy of general uncertainty and are developing contingency plans with respect to portfolio companies. However, those funds that have a large HNWI/FO LP base should be able to leverage that capital to weather the near-term storm while adding significant value to their portfolio companies.
Additionally, as the stock market faces significant headwinds in the short term, there exists an opportunity to allocate to co-investments/SPVs at more attractive valuations than in the last few years.
Co-Investment Opportunity Finally a Thing
70% of LP dollars to emerging managers comes from HNWI or family offices, and one of the most common questions that prospective LPs ask in the diligence process is the potential for co-investment opportunities. Now more than ever LPs have the chance to lean into their relationships and access highly coveted opportunities that they couldn’t before. In the past, several reasons existed for the lack of access, including:
- The round was oversubscribed so allocation was tight.
- Even when there was an opportunity, the hassle of marketing the deal to LPs isn’t worth it to GPs.
- The entrepreneur had more leverage when it came to picking investors.
Now, things have slightly changed and GPs can structure a process for their LPs around co-investments and vice versa. More on that below.
Covid Puts a Dent in Traditional Thinking
As Covid puts a strain on venture-backed companies, opportunities arise for LPs who seek co-investment opportunities to finally execute on them preemptively. Entrepreneurs who have operated with the ball in their court should be open minded to less traditional sources of financing, i.e their investor’s LPs.
Some funds have been guiding their portfolio companies to have around 18 months of cash on hand. However, from the chart below, we see that companies take on average 10 months to raise, so those that have less than 10 months of cash on hand may need to think long and hard about their options.
Executing On The Strategy From Both Sides
From the GP perspective: Those GPs who have been courting LPs for some time and who have gotten the feedback that prospective LPs may look for co-investment opportunities, now is the time to set a process in place to present opportunities to LPs. This can manifest itself in a list with the following information:
- Write ups that should include company name, description, last round valuation/size of raise, burn rate, months left of cash based on revenue decreasing by X% (this is dependent on industry).
This information should be enough for LPs to make some high level decision on which companies they may be interested in. Concurrently, GPs should be having dialogues with their portfolio companies around why taking money from LPs could benefit them in the long run.
From the LP perspective: Those family offices who have exposure to venture capital managers (who don’t have a program in place to help portfolio companies) should set up calls with their GPs and understand the cash needs of all of the portfolio companies. Even those companies that are still relatively isolated from the Covid impact could be potential contenders as they may want to extend runway or add a liquidity cushion.
If LPs have the patience to execute this at scale, they can start benchmarking discounts so as to be fair to themselves and the founders, who will need to be handheld on why they should accept a hair cut. Important note here — venture capital has been highly averse to the down round. This notion has always puzzled me. If the public markets can sell off by 20% in the last month, private markets should get somewhat impacted as well.
Conclusion
During times of distress, LPs have the chance to enhance their engagement with the GPs that they have either allocated to or are planning to allocate to. This can benefit all parties at the table—LPs get direct investment exposure, companies mitigate the need to significantly downsize, and venture funds preserve capital and potentially save an investment from write-off.
There can certainly be a lot of push back to this strategy, however I believe if done right, there is a rare opportunity for capital that is traditionally twice-removed to step in and provide a lending hand.
In the long run, it may even open up strategies for LPs that they didn’t know existed. Dedicating time now will engross those LPs deeper into the asset class that they committed to for 10–15 years.
Stay safe everyone!
I’m an early stage investor with Expansion Venture Capital based in NYC. We invest in Fintech, Proptech, Mobility, and Marketplaces. Since our inception in 2011 we have made over 100 investments including: Carta, Yieldstreet, Allbirds, Transfix, Via, Lemonade, Latch, and many more.