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Private Capital

Growing appetite for co-investment in the mid-market

Posted by on 17 November 2017
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"Old world governance, new world growth" - David A. Smith, Managing Director and Co-head of Co-investment at Capital Dynamics, joins Stephen Fishleigh, BackBay Communications, to discuss the reasons for growing interest in co-investments in the mid-market.

Can you describe your firm?

Capital Dynamics is an independent global asset manager, investing in private equity, credit and clean energy infrastructure. We regard private equity as a three-legged stool comprising co-investments, secondaries and primary fund-of-funds.  Those three legs are symbiotic.

What’s Capital Dynamics’ approach to co-investment?

Our tried-and-tested approach to co-investment has been built on direct buy-out and late-stage growth capital investments in middle market companies globally, alongside leading sponsors.  Simply put: intelligent, competitively-priced private equity.

Has this changed over time?

No, our present co-investment programme and our sixth as a team will, like its predecessor, target the mid-market.  We plan to invest the majority of our present fund’s capital in companies based in Europe and North America where we employ our proven “old world governance, new world growth” model.  We expect the remainder to be deployed in Asia and the rest of the world.  Sector diversification will be achieved by investing in leading companies in five verticals: energy & power, consumer, financial services & healthcare, industrials, technology & business services.  We’re sticking to a successful formula.


Is interest in co-investments growing and what’s driving demand?

Yes, we are delighted with having closed Capital Dynamics Mid-Market Direct IV comfortably above its initial target, our largest co-investment programme to date.  We saw increased demand from our limited partners globally.  As private equity co-investment has developed into a sub-asset class in its own right (the fact that a day of this SuperInvestor 2017 conference is dedicated to co-investment is testament to that fact), savvy investors are demanding access to private equity at lower cost without compromising risk or return.  Our research (presented at this conference) shows that intelligent co-investment can offer investors what they’re after.  We’re simply satisfying growing investor demand.

Why is the mid-market attractive for co-investments?

The mid-market comprises an extensive, global network of pre-eminent GPs.  We are proud to be an integral part of that network by virtue of our firm’s growing primary fund-of-funds business.  These pre-eminent GPs (we use the phrase “institutional quality” to describe them) are the source of the majority of our co-investment deal flow.  They professionalise and transform their portfolio companies and, to quote of them, turn them from “great into awesome”.  We’re there to help them in that endeavour, providing capital and expertise.  Intelligent mid-market co-investment provides superior returns with attractive risk characteristics.

Is there a different approach between mid-market and lower mid-market co-investment? Are there different priorities when evaluating deals?

The fundamental discipline, being that of underwriting direct investments, is the same regardless of enterprise value.  There are, however, subtle differences in market practice.  Revenue concentrations demand more attention in the lower mid-market.  Co-investment structure, governance arrangements and minority protections may differ, too.  It’s important to recognise these facets in investment appraisal and due diligence.  Experienced co-investment teams know how to navigate these subtleties.

How do you see the market for co-investments evolving?

I’m on record as having said this before but I’ll say it again: private equity co-investment has really come of age in the last few years.  Most sophisticated private equity investors now carry a co-investment arrow in their quiver. The fundamental drivers of co-investment are clear and the strong performance of the sub-asset class now has a good research underpinning. That’s good. Future growth is, I believe, assured.


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