Co-Investor

What is a co-investor?

Co-investor (in German, Mitinvestor) refers to an investor that takes part in a funding round on the terms negotiated by another investor acting as lead investor. The lead investor leads the round: it sets the valuation and the contract terms. The co-investor takes a part of the round volume, receives shares of the same class at the same price and leaves the conduct of negotiation and review to the lead investor. The participation itself is called a co-investment.

Co-investors are part of almost every institutional round, that is, every round with professional investors such as funds. Co-investor describes a role, not a type of investor. The role can be taken by further venture capital funds, corporate investment units, a family office, business angels (angel investors) or public investment funds. The basis is the term sheet negotiated by the lead investor; the participation is implemented in the participation agreement and in the shareholders' agreement, which all investors in the round sign.

In the fund business, the term additionally refers to investors in a fund who take part directly in individual companies alongside the fund. Co-investors are also mentioned in real estate projects: alongside the project developer or a fund, they provide equity for an individual property.

Division of roles between lead investor and co-investors

The lead investor negotiates valuation, share class and rights, steers due diligence and usually takes the largest amount. Co-investors join these terms. They bring capital that the lead investor does not want to provide alone or is not allowed to provide under its investment limits. They often make a contribution of their own, such as industry knowledge, access to customers or markets or experience with later rounds.

The allocation results from the target stake and round size. A lead investor often aims for a certain minimum stake and at the same time limits the amount it invests in a single company. If the capital requirement exceeds this amount, co-investors are needed. Existing shareholders who exercise their subscription right, that is, take up new shares in proportion to their existing holding, are also co-investors in the new round.

Due diligence and information basis of co-investors

Co-investors usually review less extensively than the lead investor. The lead investor generally commissions the legal, tax and financial due diligence. It often makes the reports available to all investors in the round, sometimes against a contribution to the costs. The advisers then declare in a reliance letter that the co-investors may also rely on the reports. Co-investors' own reviews often concentrate on market, business model and fit with their own strategy.

According to widespread practice, the company bears the costs of the investors' legal advice up to a maximum amount set in the term sheet. Whether co-investors additionally engage their own advisers and who pays for them must be regulated separately.

Rights of co-investors

Co-investors receive shares of the same class as the lead investor and thus the same economic rights. These include above all the liquidation preference (priority in the distribution of sale proceeds), anti-dilution protection in the event of a later round at a lower price, and subscription rights (pre-emptive rights). This is described as participation on equal terms (pari passu).

Differences exist in control and information rights. Advisory board seats, approval reservations and extended reporting obligations are often tied to a minimum stake, described in the market as the threshold for major investors. Smaller co-investors then have the statutory information and inspection rights of every GmbH shareholder (Section 51a of the German Limited Liability Companies Act, GmbHG) and the reports to which everyone is entitled by contract. Side agreements (side letters) with special rights for individual co-investors should be disclosed to all investors and coordinated with the shareholders' agreement.

Accession of co-investors to the agreements

Co-investors become parties to the participation agreement and the shareholders' agreement. If they join only after signing, for example in a second closing, this is done through an accession agreement, called a deed of adherence in the English-speaking market. If the shareholders' agreement contains obligations to assign shares, such as drag-along obligations or acquisition rights, the accession also requires notarial recording. Co-investors take the new shares, like all investors, as part of the capital increase.

Worked example: splitting a Series A between lead and co-investors

Formula: Stake of an investor = investment amount divided by valuation after the round (post-money)

A company raises EUR 10 million in a Series A at a pre-money valuation of EUR 30 million. The lead investor takes EUR 6 million. An existing seed investor holds 10% before the round and exercises its subscription right in full.

• Valuation after the round: EUR 30 million + EUR 10 million = EUR 40 million
• Lead investor's stake: EUR 6 million divided by EUR 40 million = 15%
• Open for co-investors: EUR 10 million minus EUR 6 million = EUR 4 million
• Seed investor's subscription amount: 10% × EUR 10 million = EUR 1 million
• Remaining: EUR 4 million minus EUR 1 million = EUR 3 million, split between a family office and an industry fund at EUR 1.5 million each
• Stake per new co-investor: EUR 1.5 million divided by EUR 40 million = 3.75%
• Seed investor's stake after the round: 10% × 30/40 + EUR 1 million divided by EUR 40 million = 7.5% + 2.5% = 10%

If the threshold for major investors is 5%, the two new co-investors with 3.75% each receive no extended rights, whereas the seed investor with 10% does. The threshold thus determines how many parties will take part in approvals in future.

Distinctions: co-investor, lead investor and anchor investor

• Lead investor: negotiates the terms and conducts the review. The co-investor adopts these terms.
• Anchor investor: the first investor to commit a significant amount firmly. It is usually also the lead investor and carries the round instead of joining it.
• Follow-on investment: the renewed participation of an existing shareholder. Anyone who maintains its percentage in a new round is also a co-investor in that round.
• Angel syndicate: pools many individual contributions in one company, which acts in the round as one co-investor.
• Co-investment in the fund business: A fund investor takes part directly in a company alongside the fund, often without or with reduced fees for fund management.

Common mistakes

• Co-investors courted as lead investor. Investors who in principle only join do not set a price. Months of outreach without a lead investor delay the round.
• Round without a leading investor. If many small co-investors carry the round alone, nobody takes responsibility for review, negotiation and later support.
• Too many small holdings. Every additional shareholder increases the effort for resolutions and notary appointments. Small contributions can be pooled through a joint holding company.
• No deadline for accession. Without a binding deadline, co-investors wait for the decisions of others. A fixed deadline for commitment and signing after agreement with the lead investor holds the round together.
• Hidden special rights. Side agreements with individual co-investors that are not known to the other investors lead to conflicts in later rounds.
• Thresholds not calculated. If the threshold for major investors is set without regard to the allocation, more or fewer parties receive control rights than intended.

Frequently asked questions

Can a co-investor become the lead investor?

Yes, if it wants to negotiate valuation and terms and take a sufficient amount. Often target stakes, fund size or internal investment guidelines speak against leading a round of this size.

How does a company find co-investors?

Usually through the lead investor and the existing shareholders, who bring their contacts, and through targeted outreach to funds, family offices and corporates that regularly join rounds. Most co-investors decide only when the lead investor is fixed and the term sheet is negotiated. They therefore usually join between the term sheet and the signing of the participation agreement, and in staged closings also within a period after the first closing.

Do co-investors receive the same shares as the lead investor?

As a rule, yes. They take shares of the same class at the same price. Deviations usually exist only in control rights tied to a minimum stake.

Do co-investors have to carry out their own due diligence?

Not necessarily, but they bear the risk of their decision themselves. Many rely on the lead investor's reports and additionally check the points that are material to their own strategy.

What is a party round?

A round without a lead investor, carried by many co-investors with smaller amounts. It can come together quickly but often leaves a fragmented shareholder structure without an investor that takes responsibility in difficult phases.

The Roemer Capital view

Once the lead investor is fixed, we plan with the management the allocation of the remaining volume: subscription rights of existing shareholders, desired contributions of new co-investors and the thresholds for control rights. We calculate the shareholder structure after the round before commitments are distributed.

In the process, we make sure that co-investors commit within a fixed deadline and that side agreements are known to all parties. The company's law firm implements the agreements; we coordinate documents and timetable with all parties through to closing.