How do private equity co-investments work and what are they used for?
There are many ways to invest in private equity. As more investors can now access this asset class, we describe the advantages of co-investing and include some key case studies in Europe.
Private equity is an increasingly attractive area for investors who want to diversify their portfolio.
While it is a well-known sector for many institutional investors, it is less so for individual investors.
Investing in private equity requires an understanding of some key risks - such as illiquidity - but it also requires specialised knowledge of routes to market.
Typically, a private equity programme is focused on investing in a fund. These funds may target particular market segments or sectors which can at times, limit the market opportunity.
Another way to invest in private equity is through a co-investment strategy, which can help to access more opportunities and at a lower price than investing though a fund.
What is a co-investment?
Co-investments provide Limited Partners (“LPs”), such as pension funds or asset managers, with the opportunity to invest directly into businesses alongside General Partners (“GPs”), like a private equity company.
This way of investing can provide a higher diversification across managers, sectors, strategies and geographies and even a higher degree of selectivity when assessing deals, compared to other approaches.
Co-investing also gives the opportunity to engage more actively with the companies, such as on sustainable practices and behaviours.
Co-investing in times of crisis
In times of crisis, co-investments have the ability to invest at lower entry valuations and attractive terms. Historically, investors have been reluctant to sell immediately post crisis to avoid the down-market.
And in times where liquidity in the market is scarce and merger and acquisitions (M&A) activity drops, having a close relationship with an expert GP that has insights in a certain industry can lead to better deals with lower competition and better execution.
Crises such as Covid-19 or the war in Ukraine have impacted different areas of the economy.
For example, the Covid-19 crisis has accelerated many changes in consumer behaviour, giving a strong boost to digital products and services, and also highlighted the resilience of the healthcare and business to business (B2B) technology sectors. These areas provide attractive growth opportunities, albeit likely at premium valuations.
Other resilient sectors, which may not have directly benefitted from the crisis but have held up well, also present attractive opportunities.
Overall, the effects of a crisis could represent a strategic premium for those businesses insulated from the cyclical downturn. Robust companies or those with counter-cyclical qualities will likely be in high demand, as investors look for businesses that can insulate themselves from future crises.
Fit for the future
Looking forward, there are certain features we are focusing on in our private equity co-investments.
Firstly, we look at companies that can be resilient to future crisis, such as those ‘mission critical’ businesses, meaning those that sell a product or a service that customers cannot operate without.
These are companies that have long-term growth prospects supported by megatrends such as aging population, energy transition, or hard-to-find, specialist skills.
In terms of market cap, we believe small and mid-sized companies in European family businesses can offer more opportunity for growth. We believe they can also benefit the real economy, and are more attractively valued than larger companies.
In the buyout space, small and mid companies are less reliant on the availability of large debt packages and financial engineering to support returns and their transformation (investing in new systems and technology, hire new management). This makes them less dependent on the global capital markets, and therefore, they are less correlated with market returns.
Below are examples of companies that typify these characteristics, that we think are well positioned for growth in the years ahead.
What does it do?
Mintec sells a software product that allows real-time consultation of price trends of commodities, which are not traded on the major indexes.
For example, the price of commodities such as fruits, vegetables, meat, and eggs, varies depending on the season or where they are produced. Mintec sells its solution either to large food companies or to large supermarket chains. These firms then use them to make internal decisions and to negotiate with suppliers.
Why do we like it?
Mintec is an investment we made with growth investor Synova, a historical and strategic partner of Schroders Capital since 2012.
The investment was completed in April 2022, just two months after the beginning of the Ukrainian crisis and when energy and commodity prices started to increase. In such volatile environment for prices, Mintec’s services on prices tracking and analysis proved fundamental for its users.
Why we backed Mintec
There are three main reasons why we back Mintec.
Firstly, the food industry is still an inefficient market. Food producers, traders and retailers have little to no visibility on prices and conduct their negotiations without reference to a common benchmark.
The second reason is that Mintec offers opportunities for price forecasting and price building based on commodity prices. For example, establishing the price of a pizza sold by a supermarket will depend on the price of raw materials such as flour, tomatoes, mozzarella cheese and other ingredients.
Lastly, the company operates in a market that has extremely high barriers to entry. It is not at all easy to replicate a software product such as Mintec. The company has been operating in the industry for over 20 years, and is the only product able to provide accurate forecasting, thanks to the transformative acquisition of forecasting business Kairos in 2021.
What does it do?
Easypark is a European mobile payment application for public parking. The company was founded in 1998 in Sweden and has since expanded. It grew first into the rest of Scandinavia and now it is in more than 800 cities in Europe.
Since our first investment in 2018 it has grown quite rapidly. When you have to pay for parking, you don't always have cash with you, especially today. That’s where having an app comes in handy – Easypark was easy to implement and easy for people to use.
Why do we like it?
Easypark first relied on a buy-and-build private equity strategy to become a local leader. It then grew to become a global leader.
We reinvested in EasyPark in 2021, when Easypark acquired ParkNow, a player with a big exposure in in the US, UK and Benelux.
As of today, the company is performing extremely well. Easypark also continues to expand on product offerings. When we first invested, it was mainly for public parking, but today it also offers corporate parking, it has agreements with airports, and with big parking houses for institutions.
The company also continues to see buy-and-build opportunities add-ons across Europe and in the US. At the end of this investment period, we will have created a global leader in a niche market.
What does it do?
Headfirst is a Dutch, tech-enabled HR sourcing platform. It helps companies with their HR services in particular in the IT sector. It is the second largest player in the Dutch flexible work market, and first highly skilled flexible workforce provider (100% white collar and 80% IT professional focus).
Why do we like it?
The labour market for IT skilled jobs such as software engineers is very tight in Western Europe and even tighter in the Netherlands. We believe this represents a growth opportunity for investors, with more than 4 vacancies available per job searcher.
Meanwhile, this market is highly fragmented, not only in the Netherlands, but also at a European level. Therefore, there is a compelling opportunity to accelerate the growth of the company through M&A in the Netherlands as well as expanding internationally.
Any reference to sectors/countries/stocks/securities are for illustrative purposes only and not a recommendation to buy or sell any financial instrument/securities or adopt any investment strategy.
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The views and opinions contained herein are those of Schroders’ investment teams and/or Economics Group, and do not necessarily represent Schroder Investment Management North America Inc.’s house views. These views are subject to change. This information is intended to be for information purposes only and it is not intended as promotional material in any respect.