A co-investment is a direct investment in a single company that you make alongside a private equity or venture capital fund manager, using a separate legal vehicle the manager sets up for that one deal. The manager, already investing through their main fund, invites select investors to put additional capital into a specific target the fund alone cannot fully absorb. In exchange for concentrating your risk on one business, you typically pay lower fees than you would in the underlying fund, and you get exposure to a deal the manager has high conviction in.
Co-investments are private, illiquid, and restricted to investors who meet specific financial thresholds. They are not a substitute for a diversified portfolio, and they are not designed for capital you might need back on a set schedule. What follows is how they are put together, who can participate, how the economics work, and what happens from invitation through exit.
How a Co-Investment Is Put Together
Two roles sit at the center of every co-investment. The General Partner (GP) is the active manager who sourced the target, ran diligence, and negotiated the deal. The Limited Partner (LP) is the passive investor who provides additional capital so the transaction can close. The GP keeps decision-making authority over the investment; the LP relies on the GP’s expertise and operational involvement to drive value at the company.
To keep the deal legally separate from everything else the GP manages, the GP creates a Special Purpose Vehicle (SPV), usually a limited liability company that exists only to hold the ownership stake in the target company. The LP buys an interest in the SPV, not in the target directly. This walls the co-investment’s assets and liabilities off from the GP’s main fund, where the LP may also be invested. If the specific deal goes wrong, the fallout stays inside the SPV.
The terms live in a standalone co-investment agreement or a side letter attached to the main fund’s limited partnership agreement. Those documents cover how the GP will manage the investment, what information the LP can see about the company’s finances, and how profits will eventually be split. Most agreements follow a standardized template, and side letters address individual LP concerns around tax treatment, reporting, or specific commercial terms.
Who Can Participate
Because co-investments are private placements exempt from the disclosure rules that apply to public offerings, federal securities law limits who can invest. Income and asset tests stand in for financial sophistication.
Accredited Investors
The baseline is accredited investor status under Rule 501 of Regulation D. An individual qualifies by meeting either a net worth test or an income test. Net worth must exceed $1 million, excluding the value of your primary residence. Income must be at least $200,000 individually, or $300,000 jointly with a spouse, in each of the two most recent years, with a reasonable expectation of the same level in the current year.1SEC.gov. Accredited Investor Net Worth Standard
Entities qualify too. Corporations, partnerships, LLCs, trusts, 501(c)(3) organizations, employee benefit plans, and family offices meet the standard if they hold more than $5 million in assets. An entity whose equity owners all individually qualify as accredited investors also passes, regardless of the entity’s total assets.2SEC.gov. Accredited Investors
Qualified Purchasers
Some co-investments, especially those structured through funds relying on the Section 3(c)(7) exemption from Investment Company Act registration, require the higher qualified purchaser standard under Section 2(a)(51) of the Investment Company Act of 1940. An individual qualifies by owning at least $5 million in investments. An institutional investor acting on a discretionary basis must own and invest at least $25 million.3Cornell Law Institute. 15 USC 80a-2(a)(51) – Qualified Purchaser What counts toward those thresholds is defined by SEC regulation.4eCFR. 17 CFR 270.2a51-1 – Definition of Investments for Purposes of Section 2(a)(51)
Beyond the regulatory tests, minimum commitment amounts are high. Single-transaction minimums frequently run into the hundreds of thousands or millions of dollars. There is no public market for these interests and no secondary market to speak of, so participants must be prepared to hold the position for years and to absorb a possible total loss of capital.
Fees and the Payout Waterfall
A big reason investors pursue co-investments is the fee discount compared with the underlying fund. A standard private equity fund typically charges about 2% annually on committed capital plus 20% carried interest, which is the manager’s share of profits. Co-investments frequently come on what the industry calls a “fee-and-carry light” basis, with management fees reduced to zero and carried interest in the 5% to 10% range. Some deals carry no fees or carry at all.
The logic is that the GP is already managing the target company through the main fund, so administering an additional SPV is not much extra work. Favorable terms attract the outside capital the GP needs to close a deal that would otherwise blow through the fund’s concentration limits. The LP gets exposure to a high-conviction deal at a fraction of the usual cost, a benefit the industry sometimes calls “co-investment alpha.”
The economics are documented in the SPV’s operating agreement, which sets the distribution waterfall. A common structure returns all contributed capital to the LP first, then pays a preferred return of around 8%, sometimes called a hurdle rate. Only after those two layers are satisfied does the GP begin collecting carried interest on remaining profits. That order protects the LP’s downside and aligns the GP’s payout with strong performance.
How the Deal Actually Happens
A co-investment starts when the GP identifies a target through the main fund’s deal pipeline. After diligence on operations, financials, and growth potential, the GP decides whether the deal is too large for the fund alone, or whether concentration limits prevent the fund from taking a bigger stake. If so, the GP issues a co-investment invitation to selected LPs, typically those who have expressed interest in direct deals or who have shown they can move quickly.
The invitation includes an investment memorandum describing the target business, the proposed transaction terms, the expected holding period, and the fee structure. The LP runs their own review against portfolio strategy, risk tolerance, and liquidity needs. Timelines are tight. Because the GP often needs to close on a set schedule, LPs may have only a few weeks to decide.
If the LP proceeds, the parties sign a subscription or joinder agreement that binds the LP to the SPV’s terms.5U.S. Securities and Exchange Commission. Subscription Agreement The GP then issues a capital call, a formal notice directing the LP to wire funds to the SPV’s account by a specified date. Once the money lands, the GP completes the acquisition and the LP holds an interest in the SPV until an exit occurs.
What the LP Actually Controls and Sees
The GP keeps control over major decisions, but co-investors, especially those writing large checks, can negotiate real oversight. Depending on the commitment size, a co-investor may get the right to nominate a director to the portfolio company’s board. Where a full seat is not available, an observer right is a common alternative: the LP designates someone who can attend board meetings and monitor decisions but cannot vote.
Co-investors often negotiate approval rights over actions that could materially affect their investment. These typically cover fundamental transactions such as mergers or asset sales, related-party transactions, debt above a specified threshold, or changes to the company’s organizational documents. Those protections limit the GP’s ability to make moves that dilute the LP’s stake or change the nature of the deal.
On the reporting side, co-investors should expect monthly or quarterly financial statements from management, plus annual audited financials, budgets, and forecasts. Some agreements also require the GP to notify co-investors of significant events like litigation against the portfolio company. These rights matter both for monitoring the investment and for meeting the LP’s own tax and regulatory reporting obligations.
Risks You Are Taking On
The upside of co-investing comes with risks a diversified fund partly mitigates.
Concentration
Your capital is tied to one company. In a diversified fund, a single failed deal is absorbed by the rest of the portfolio. In a co-investment, a failed deal means a total loss of the capital committed to it. LP-side diligence matters more here than in a fund commitment because you are betting on one business, one management team, and one industry thesis. Investors who build co-investment programs generally try to spread commitments across multiple deals over time.
Adverse Selection
You can only invest in the deals the GP chooses to offer, and that choice is not random. Academic research has found that GPs tend to offer co-investment when a deal is too big for the fund alone, so co-investments skew toward larger, more complex transactions. Some evidence suggests these deals produce comparable cash-on-cash returns to the fund’s other investments but take longer to exit, which lowers annualized returns. The underlying concern is that a GP may reserve their best opportunities for the fund itself, where they earn full fees, and offer co-investment on deals where they want to share risk. Not all research agrees, and many institutional investors report strong co-investment results. The protection is having the resources to evaluate deals independently and the willingness to decline invitations.
Illiquidity
There is no public market for your SPV interest, and most co-investment agreements restrict or prohibit transfers without the GP’s consent. The median holding period for private equity-backed companies has reached roughly six years, and individual deals can run considerably longer. Assume your capital is locked up until the GP arranges a sale, recapitalization, or public offering.
Taxes
Co-investments carry tax obligations that differ from owning public stock or a standard mutual fund position. The SPV is typically structured as a partnership or an LLC taxed as a partnership, so income and losses pass through to investors rather than being taxed at the entity level.
Schedule K-1 Reporting
Each year the SPV is active, the LP receives a Schedule K-1 (Form 1065) showing their share of income, deductions, gains, and losses. Partnerships must furnish the form to partners by the 15th day of the third month after the end of the partnership’s tax year, which is March 15 for calendar-year partnerships.6Internal Revenue Service. Publication 509 (2026), Tax Calendars K-1s from private equity vehicles often arrive late, and investors frequently need to file tax extensions as a result. The LP is responsible for tracking basis in the partnership and applying any relevant loss limitations, including basis, at-risk, and passive activity rules.7Internal Revenue Service. Partners Instructions for Schedule K-1 (Form 1065)
The Three-Year Holding Rule on Carried Interest
Under Section 1061 of the Internal Revenue Code, capital gains allocated with respect to a carried interest (an “applicable partnership interest”) must meet a three-year holding period, rather than the standard one year, to qualify for long-term capital gains rates.8Office of the Law Revision Counsel. 26 USC 1061 – Partnership Interests Held in Connection With Performance of Services The rule primarily affects the GP, not the LP, but it shapes GP incentives around exit timing: a manager seeking favorable treatment on carried interest has a reason to hold at least three years.9Internal Revenue Service. Section 1061 Reporting Guidance FAQs
Tax-Exempt and Foreign Investors
Two boundary cases are worth flagging because they surprise investors who assume co-investments work the same for everyone. If a co-investment uses leverage, tax-exempt entities such as endowments, foundations, and pension funds can generate unrelated business taxable income under IRC Section 514.10Office of the Law Revision Counsel. 26 USC 514 – Unrelated Debt-Financed Income Income attributable to debt-financed property flows through to the tax-exempt LP as UBTI even when the underlying income would otherwise be exempt.11Internal Revenue Service. UBIT Special Rules for Partnerships Foreign investors face a parallel issue: if the partnership is engaged in a U.S. trade or business, the foreign partner is generally treated the same way, and their share of U.S.-source income becomes effectively connected income taxed at graduated rates.12Internal Revenue Service. Effectively Connected Income (ECI) Both categories require structuring attention before the money goes in.
How a Co-Investment Ends
A co-investment concludes on a liquidity event, most commonly the sale of the portfolio company to another buyer, a recapitalization that returns capital to investors, or an initial public offering. The GP controls the timing and method of exit. The co-investor generally has no unilateral right to force a sale.
Two contractual provisions govern how the LP participates in that exit. Tag-along rights, sometimes called co-sale rights, let the LP sell their interest on the same terms and at the same time as the GP’s fund, so the co-investor is not left behind in the transaction. Drag-along rights work the other way: they let the GP require the LP to sell when the fund exits, preventing a single co-investor from blocking a deal. Drag-along provisions often include safeguards, such as applying only to full exits or requiring the transaction to meet a minimum rate of return.
Sale proceeds flow through the distribution waterfall in the SPV’s operating agreement. Capital comes back to the LP first, then the preferred return, then any remaining profits split between the LP and the GP at the agreed carried interest percentage. Once distributions are complete and final tax reporting is done, the SPV is dissolved.