How VCs can get the most out of co-investing alongside LPs

William Kilmer Contributor

William Kilmer is managing partner with C5 Capital, a venture capital fund investing in the secure data ecosystem. He was formerly an operating partner at Mercato Growth Partners and served as CEO and chairman of PublicEngines (acquired by Motorola), and Avinti (merged with M86 Security) and served as chief marketing officer/chief strategy officer of M86 Security (acquired by Trustwave).

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It has rarely been easier for people looking to invest. Nontraditional investors, which include anyone outside of traditional VC firms investing in venture capital deals, are increasingly making their presence felt in the investing community.

McKinsey found that the value of co-investment deals has more than doubled to $104 billion from 2012 to 2018. And by some counts, there are as many as 1,600 “nontraditional” investors helping to fund venture capital deals in 2021.

The primary motivator for nontraditional investors is seeking better returns, and investing alongside VC funds is a great way to achieve that. A recent Preqin study shows co-investing funds significantly outperform traditional funds.

Research shows that 80% of investors found their co-investments outperforming private equity fund investments, with 46% outperforming by a margin of more than 5%. Investors also benefit from a generally less expensive fee structure compared to traditional private equity or VC funds.

When evaluating deals, keep in mind that most companies are not going to be the next tech unicorn, so set realistic views on exits.

Co-investors can also profit by sharing the investment risk, which benefits all investors and builds loyalty and trust. And because this kind of investing requires a hands-on approach, investors get the chance to work closely with top sponsors — the general partners (GPs) — to foster deeper relationships and gain a better understanding of the GPs’ investment strategies and deal review processes. For new investors, building these relationships is essential for strengthening their own investment skills in the long run.

Why VCs love alternative investors

Alternative investors aren’t the only ones who benefit from co-investing, it’s also a boon for GPs. They gain a broader array of funding options by partnering with alternative investors, and they can leverage their own capital more effectively with prospective investments.

VCs have other benefits too: While co-investing LPs remain passive in the business, the VC can use that voting power to preserve investor rights and consolidate decision-making. It also allows them to put more money to work in any company while staying within diversification limits.