Levering Up for Co-Invest: Good or Bad Idea?


Seeking some advice and guidance here to see if I'm making a terrible mistake or a big-brain financial move. At my current firm I am able to participate in a co-invest program as an Associate and envision myself staying with the firm for the next few years.

Our current Fund is returning 2.5x+ Net MoMs and 25%+ Net IRRs with a long track record of delivering consistent, top quartile returns. On a fee and carry-free basis this is even higher. This is not a flex, just indicating that I am 90% confident that my Firm will continue to deliver similar returns over the next 10 years. Loss ratios are also extremely low and I am 99% confident that I would not lose any money (outside of the time value of having it locked up for at least 5 years).

Under my current co-investment program I have no limits to the amount that I can co-invest and believe this is the best place to park my money and have it locked up for the next ~5 years. Therefore, does it make sense for me to leverage myself and dump in as much money as possible into this program? My current firm extends leverage but I am thinking of taking on additional loans to increase my commitment (under our current program we contribute $XX of each $M that is invested). With rising interest rates I recognize this might be a bad idea so another alternative would be pulling from my future inheritance and investing this instead? If I can get my parents comfortable would it make sense to take $300K of future inheritance and dump it in my Fund? I do not plan to purchase a home or make any other major purchases in the near future that would require access to liquidity now. I currently have ~$200K co-invested right now.

Someone please tell me why this is a terrible financial idea (if so) outside of the usual risk factors (Fund could do poorly, market volatility, etc.).


Comments (22)

  • Associate 3 in IB-M&A
May 4, 2022 - 6:58pm

I would not do this. Obviously the outside loan is a terrible idea (and truthfully doubt most banks would approve given your current exposure), but I really think even the inheritance would be putting you in too deep into a single company. Don't forget you're also highly levered personally in that you work there and if the fund goes under, you'd be both without a job and without a good portion of your inheritance. Just because loss ratios are low now (in one of the best markets in financial history) doesn't mean that will continue especially with how rapidly the macro environment is changing.

Unless your inheritance is in the mid 7 figures and $300k literally doesn't matter to you, this move has a ton of downside 

  • Associate 2 in PE - Growth
May 4, 2022 - 7:28pm

Thank you for the candid reply; and well noted on diversification risk. Just curious - is there a premium that I should consider at the cost of diversification? I guess I'm just trying to solve to see what the 'value' of that diversification is.

If the upside is 35%+ IRRs/3.0x MoM is that 'worth' the lack of diversification? Or do you view it as no amount of upside is enough to put all your eggs in one basket.

  • Associate 3 in IB-M&A
May 5, 2022 - 6:48pm

no, there is no dollar amount that I'd put everything in one basket like this. the risk/return is just not justified at any number

  • Investment Analyst in HF - EquityHedge
May 4, 2022 - 7:14pm

Past performance is not indicative of future results.

  • VP in PE - LBOs
May 4, 2022 - 8:30pm

I'd keep it in the context of an overall portfolio. Which is another way of making sure you're well diversified. I think there is some merit to leaning in a little bit given you're young enough to take some risk, but I wouldn't go as far as to go into significant debt or plow inheritance in. We may be heading into a recession, maybe those returns look wildly different or maybe they look OK but it takes 7 years to come back per deal rather than 5. No one has any idea. Do you think all of the "good" funds who have hit down fund raises expected their returns to go down? No, I'm sure they were just as confident as you. Maybe you fall in love and do want to buy some real estate to settle down. Maybe someone you love or you gets really sick. Maybe you just totally burn out of your job or just get fired. Life changes. I'm certainly not suggesting to never take any risk (our whole job is risk assessment) particularly when young, but just be mindful you're not setting your future self up for being unnecessarily stressed.

  • Investment Manager in HF - Other
May 4, 2022 - 9:44pm

Will just reiterate what others have said. The two most important points to me are:

1) never, ever, be that confident in results. Look at what has happened (through history and currently) to "top" funds. The world changes and while I think you should take risks at this point in your life, you are a bit blind to the risk 

2) as has already been pointed out, you are so levered to your fund already. You always want to avoid the "risk of ruin", and you are setting yourself up for this to be a possibility. You should already have great terms (comp, invested capital, etc) that this seems like an unnecessary risk. 

I'm all for taking some risk, but you need a safety net and some diversification. I wouldn't do it (and I'm highly levered at my firm, but not to those levels). 

  • Principal in PE - LBOs
May 4, 2022 - 10:22pm

As someone who was in your shoes 8 years ago wish I did this. Would be worth $1-1.5MM or more today. Low downside and future NW compounding worth the low risk profile. If you lose it, your career upside outweighs the loss downside (given this is $300K and you are likely making close to that amount today and have a variety of career options where can take the L). If you're in growth equity as profile suggests make sure your firms portfolio is appropriately downside protected otherwise might be more careful - has been a nice 10 years for growth equity. 

One additional piece of advice - make sure you know what happens if you leave your firm. If they can buy back at fair market value and we are in a recession where both promotion more difficult + portfolio marked down that could create a tough situation. 

Most Helpful
May 6, 2022 - 3:48pm
chihayafull, what's your opinion? Comment below:

Don't listen to these pussies and lever the fuck up. If you believe in your team and your investments (e.g., you as an Associate don't think you're pushing dumpster fire investments), then that's probably a pretty good indicator. You're so much more educated on your fund portfolio than you are on just plowing into the market.

Everyone loves talking about risk weighting, exposure, etc., which is fine. But I don't see how there could be all that much downside compared to alternatives (public markets, other funds, not investing?)

And also, being ~26ish, I don't really see a "risk of ruin." The biggest risk was pointed out above which is they force you to get bought out at mark, in which case you could get fucked if macro timing is bad and you're forced to monetize rather than ride it out. Being young while being in the 99% percentile for income means you can afford to take these risks, and the potential payoff could be huge.

  • Principal in PE - LBOs
May 19, 2022 - 12:43pm

I'm more inclined to agree with you than not.

For the others saying no - you don't know OP's situation, either. OP could be an absolute rock star and is just as engaged with their portcos as partners. and there is absolutely value in knowing companies vs. allocating assets you don't know as well.

If I could have levered up when I was associate at my fund, I would have 1000% done it.

  • VP in CB
May 6, 2022 - 4:28pm

I'm a big proponent and view coinvest as a significant wealth creation tool. In a similar boat where my firm provides it across all our fund strategies based on gross returns on a fixed dollar per deal and guarantees loans from a leverage line provider for up to a really high LTV per deal. I'm putting as much as I can into our program. Unlike most firms running a singular buyout strategy with only a handful of portfolio companies, we are a much bigger platform across different strategies, which helps slightly mitigate the concentration concerns such that if any one fund underperforms I will still be in many other deals across the other ones.      

  • Principal in PE - LBOs
May 15, 2022 - 10:03am

100% Agree 

  • 4
May 10, 2022 - 3:07am
Z1196, what's your opinion? Comment below:

I saw a lot of kids do this In '05 and '06. Bad news was it was a shitty financial decision. Good news is they made plenty of money the last 15 years. 

  • Analyst 1 in IB-M&A
May 10, 2022 - 8:52pm

What's the logic for being a shitty financial decision - did a lot of your friends' go under? Did a pitchbook search on megafunds with 06 vintages, and the average IRR is HSD (KKR @ 9%, APO @ 9%, Bain @ 7%). Even running that unlevered you'd outperform the S&P. 

I do think it's worth more caution today given the possible shift of rates upwards so would make sure you truly believe in your fund's strategy, but I'm not sure you could credibly argue that those that invested in '06 really did poorly.

May 14, 2022 - 2:03am
Z1196, what's your opinion? Comment below:

You are showing naïveté. Nobody without the benefit of hindsight nobody knows which funds will prospectively be top quartile. As an associate, you don't typically get the funds performance, you get the performance of the deals you happen to invest in. When the fund does a rescue financing or buys the portcos bonds at a discount you may or may not have the opportunity To participate, you may or may not have the capital to participate. Thinking your downside in coinvesting in PE (no matter who the sponsor is) is only an 8% return reflects a fundamental misunderstanding of the risks involved.  Gflty 

  • Associate 3 in IB-M&A
May 14, 2022 - 1:11pm

Agree with everything said above, plus you're cherry-picking top MFs which is not the situation this guy is in... KKR is of course going to have excellent returns as they can get out of a bad situation or two pretty easily, and hedge with many other top-tier investments. At a smaller fund, one or two bad deals might turn the fund upside down and it did to many in 05/06.

May 10, 2022 - 7:29am
franco, what's your opinion? Comment below:

Can you share a bit more about the fund strategy? An approach that is consistently delivering low loss ratios should skew right and as others have said you want to have high confidence that will stay the case even under a more negative macro context and I would add significantly bigger fund size.

The other thing to consider is who in your fund is generating those returns, if it's a single individual then you should worry about key man risk (as much as LPs do).

Lastly think about the alternative eg is it putting dollars into SP500. You could replicate some of the leverage through margin account but I find that scarier than leveraging a PE fund investment.

If you get comfortable with these risks then absolutely you have an opportunity to invest fee free in a top quartile fund that others don't and you have multiple layers of leverage (your investment and the underlying). If your fund uses a sub line then the draw down will be more manageable as well.

  • Associate 3 in PE - Other
May 14, 2022 - 11:52am

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