Co-investment

An investor in a fund owns a slice of everything the fund owns. Co-investment lets that investor take a second, direct helping of one particular company.

Under the regulations, co-investment means investment made by a Manager or Sponsor or investor of a Category I or Category II AIF in investee companies where such AIF makes investment. The investor negotiates the right at the time of subscribing to the fund — it is not a standard feature, and managers generally offer it to preferred investors.

The attraction is concentration. Without a co-investment right, the investor's return depends on the performance of the scheme alone. With it, the investor can take larger direct exposure to the opportunities it likes most, which can lift the return on the whole portfolio.

The risk is the mirror image, and it is why the rules exist: the same investor now has two positions in one company, on terms that could easily be better than the fund's.

Two routes. Co-investment by investors of a Category I or Category II AIF is available either through a co-investment scheme launched under the AIF Regulations, or through a Co-investment Portfolio Manager under the SEBI (Portfolio Managers) Regulations, 2020.

The fairness rules, which apply either way:

• The terms of co-investment by a manager, sponsor or co-investor shall not be more favourable than the terms of investment for the Category I or II AIF.
• The terms of exit, including the timing of exit, shall be identical to the AIF's exit from that investee company.
• The manager shall not provide advisory services to any investor other than the investors of a co-investment scheme or the clients of a Co-investment Portfolio Manager, for investment in securities of investee companies where the fund invests.

The conditions specific to a co-investment scheme:

• A shelf placement memorandum is filed with SEBI through a merchant banker, with the specified fee — Rs 1,00,000 for filing a shelf placement memorandum for launching co-investment schemes.
• Only accredited investors of the Category I or II AIF are eligible to invest in a co-investment scheme.
• Each co-investment scheme shall invest in only one investee company, and a separate scheme is launched for each co-investment in accordance with the shelf placement memorandum.
• A co-investment scheme shall not invest in units of AIFs.
• The scheme shall be wound up on exit from the co-investment.

Accredited investors are also served through separate co-investment vehicles with their own bank and demat accounts.

Godavari Growth Fund II, a Rs 1,400 crore Category II AIF, is investing Rs 120 crore for 18% of a specialty chemicals company at a pre-money valuation of Rs 547 crore. A sovereign fund holding Rs 300 crore of commitments in Godavari II negotiated a co-investment right at subscription and wants Rs 80 crore of direct exposure.

The manager files a shelf placement memorandum through a merchant banker — filing fee Rs 1,00,000 — and launches a co-investment scheme dedicated to this one company. The sovereign fund is an accredited investor, so it is eligible.

Its exposure to the chemicals company becomes:

Through the fund : Rs 300 cr / Rs 1,400 cr x Rs 120 cr = Rs 25.7 cr
Co-investment    :                                       Rs 80.0 cr
Total                                                    Rs 105.7 cr

Four times the exposure it would have had through the fund alone — which is the entire commercial point.

What the manager may not do: give the co-investment scheme a lower entry price, a liquidation preference the fund does not have, or a right to sell six months before the fund does. Terms can be no more favourable than the fund's, and the timing of exit must be identical. When the block is sold in year six, both positions go on the same day, and the co-investment scheme is then wound up.

Nor can the manager put a second company into the same scheme — one scheme, one investee company.

Chapter 3 introduces co-investments at 3.12 as a market practice, Chapter 4 gives the regulatory conditions at 4.1.5, and Chapter 7 (Investment Process and Governance of Funds) returns to them at 7.5. The examinable points are the definition, the two routes (co-investment scheme or Co-investment Portfolio Manager), the "not more favourable" and "identical exit timing" rules, and the co-investment scheme conditions — accredited investors only, one investee company per scheme, no investment in units of AIFs, shelf placement memorandum filed through a merchant banker for Rs 1,00,000, wound up on exit.

• Co-investment is alongside the fund, not inside it. The investor holds securities of the investee company directly or through a dedicated scheme; it is not a larger unit holding in the AIF.
• Only Category I and Category II AIFs are covered by this definition. Do not extend it to Category III.
• Only accredited investors may invest in a co-investment scheme — an ordinary investor in the AIF with a co-investment right must use the Co-investment Portfolio Manager route.
• "Not more favourable" is a ceiling, not a floor. Co-investment terms may be worse than the fund's; they may never be better.
• The exit timing is identical, not merely similar. This is the rule that stops a manager quietly letting a favoured investor out first.
• One scheme, one investee company, and the scheme winds up on exit — it is not a standing vehicle that recycles into the next deal.
• Co-investment rights are negotiated at subscription, not claimed later, and are not a standard feature of every fund.