In an increasingly challenging fund raising environment, investors are requiring investment fund managers to have ‘skin in the game’ through making a co-investment in the investment fund that they manage. 

Typically, investors are expecting investment fund managers to make a co-investment of between 1% to 3% of the investment fund’s size. This can be a considerable cash outlay, particularly for an emerging investment fund manager.  For example, in a £100 million investment fund, the co-investment commitment could be between £1 million to £3 million.

At some investment fund managers, the co-investment commitment is funded by the most senior fund executives who may have the cash available to fund this commitment from, for example, post tax carried interest cash distributions received from other investment funds. At other managers, all of the fund executives are required to fund the co-investment commitment with the amount paid by each individual fund executive linked to their seniority within the manager. 

In both of these circumstances, individual fund executives must have sufficient cash available to fund the co-investment commitment when called upon by the investment fund. 

Funding co-investment commitments

Own cash 

Some investment fund executives will use post tax cash from their profit share as a member of the Fund Manager LLP, or from salary as an employee of the Fund Manager LLP / Ltd, to fund their co-investment commitment whilst others may use post tax cash from co-investment or carried interest returns from other investment funds.

External cash

There are also a number of bespoke finance houses who lend to individual fund executives to enable them to fund their co-investment commitments although, in a period of high interest rates, this may not be an attractive option for individual fund executives especially as the executives will normally be required to provide security to obtain the loan

Lending from investment fund manager

As an alternative to external borrowing, some investment fund managers make loans to individual fund executives which are funded by the annual fund management fee received by the fund manager.  These loans are typically interest bearing and may be subject to vesting conditions.  

Management fee waiver 

There has been a recent trend for investment fund managers to use a management fee waiver to fund their co-investment commitment.  

A management fee waiver - which is commonly used in the US - is where the investment fund manager agrees to waive the right to receive part of the annual fund management fee from investors for a number of years (typically, four to five years) with the amount waived drawn by the investment fund from investors and treated as being invested in the investment fund by the investment fund manager.  

The UK tax implications of a management fee waiver for UK tax resident individual fund executives are complex and, commercially, the investment fund manager will need to obtain investor consent to implement a management fee waiver and be able to operate the investment fund management business with reduced management fee income for a number of years. 

Summary 

Funding co-investment commitments can be a considerable cash outlay for investment fund managers.

There are a number of options to fund co-investment commitments and the most appropriate option will based on the specific circumstances of the investment fund manager. 

The UK tax treatment of funding co-investment (along with any returns from co-investment) is complex and will be covered in a future article.  

We recommend that UK tax advice is always obtained by investment fund managers on both funding co-investment and the receipt of co-investment returns.