Law360 reports a trend that we have been seeing in private equity fundraising for a couple of years — high net worth individuals (HNWs) and family offices (FOs) competing with pension funds and large institutional investors for an increasing share of private equity fund allotments.  While HNWs and FOs have always been major players in venture capital and growth equity funds, their move to broader private equity is a shot in the arm for smaller and first-time buyout funds. Private equity is again in high demand following record limited partner distributions, which have moved private equity returns north of public equity market returns.  According to Preqin, HNWs now account for 10 percent of large private equity fundraising (almost doubling since 2008), and we see a much higher share for smaller and first-time funds. HNWs and FOs do not typically demand as favorable fee, carry and co-investment terms as larger institutional investors, and fund general partners welcome less dilutive terms during a period when large investors have negotiated for increasingly favorable “early” and “large” investor breaks. In fact, to get into larger top-tier funds, individual investors are often willing to pay higher fees and absorb a higher carried interest.
But now, especially for smaller and first-time funds, HNWs and FOs are gaining enough clout as return investors that they are also able to negotiate priority co-investment rights and, if they are a large investor in the fund and commit at the first fund close, lower fees and even a share of the carried interest. From the fund general partner’s perspective, limited partner co-investments are often preferable to club deals or partnering with other funds in transactions in terms of portfolio company control and transaction simplicity. However, while “collusion” claims have seen a decline in large fund club deals, we expect HNWs and FOs will continue partnering with other like-minded investors in deals requiring more capital or shared domain expertise. 
The trend in investor demand for co-investor rights may actually portend a more challenging fundraising environment as fund investors increasingly choose to make direct investments in private companies.  We see this phenomenon occurring with family offices in the lower middle market as well as with bigger direct plays by pension funds. Preqin reports that more than 25 percent of investors that allocate less than $250 million to private equity allocate more than 11 percent of their private equity allocation to co-investments. The appetite for co-investments is being driven not only by a desire for more “hands-on” investing but also by the quest for reduced fees and higher returns, as co-investments are often free of management fees and carry.
HNWs and FOs in particular view private equity funds as a ticket to direct investment opportunities via co-investment rights. In contrast to pension funds focusing on infrastructure and more stable debt-like returns, many HNWs and FOs are concentrating on “impact” investments in earlier-stage opportunities in specific industries with which they have some affinity or experience, such as education, healthcare, renewable energy and sustainability. And still others are drawn to higher return opportunities with more traditional lower middle market companies that can be leveraged with low-interest bank debt and mezzanine loans. Of course, with these higher return expectations come higher investment concentration risk and the need for more “in-house” family office management and investment expertise. HNWs, FOs and even hedge and investment fund principals are becoming more and more institutional and disciplined in their approach to private equity but will continue to offer funds an attractive alternative pool of limited partners.