Co-Investment Arrangements in Hong Kong Private Equity: Legal Framework and Documentation

Introduction

Co-investment—whereby investors invest directly alongside a private equity or venture capital fund in a specific portfolio company—has become a central feature of the Hong Kong private equity market. Institutional investors, family offices, and sovereign wealth funds increasingly demand co-investment rights as a condition of committing capital to a fund, seeking to deploy additional capital at lower fees and to build direct exposure to their highest-conviction investments.

This article examines the legal framework for co-investment arrangements in Hong Kong, the typical documentation used, the key terms that should be negotiated, and the regulatory considerations that arise.

What Is a Co-Investment?

A co-investment involves an investor (the co-investor) investing directly in a portfolio company alongside a private equity fund managed by the general partner (the GP). The co-investor typically invests through a co-investment vehicle (often a special purpose vehicle or SPV) that sits alongside the fund in the portfolio company's capital structure, rather than through the fund itself.

Co-investments are typically offered to selected LPs (and sometimes to third parties) on a deal-by-deal basis when the GP has identified an investment opportunity that is too large for the fund alone, or where the GP wishes to reward key LPs with preferential access to specific deals.

Advantages of Co-Investment

For co-investors, the principal advantages are:

• Fee savings: Co-investments are typically offered on a no-management-fee, no-carry (or reduced-carry) basis, significantly reducing the cost of capital deployment compared with investing through the fund
• Portfolio concentration: Co-investors can build larger positions in their highest-conviction deals than their fund allocation would permit
• Direct relationships: Co-investors may develop direct relationships with portfolio company management
• Transparency: Co-investors typically receive more detailed information about specific investments than they do through fund reporting

For GPs, co-investments allow deployment of larger deals without breaching fund concentration limits, strengthen relationships with key LPs, and may attract new capital sources.

Co-Investment Structures

Co-Investment Vehicle (SPV)

The most common structure is a special purpose vehicle (SPV)—typically a Cayman Islands exempted company or a Hong Kong limited company—that aggregates the co-investors' capital and holds the direct investment in the portfolio company. The SPV is managed by the GP (or an affiliate) under a co-investment management agreement.

Direct Participation

In some transactions (particularly where a small number of large co-investors are involved), co-investors invest directly in the portfolio company as shareholders alongside the fund, without an intermediate SPV. Direct participation simplifies the structure but requires each co-investor to enter into the portfolio company's shareholders' agreement and tag-along/drag-along arrangements directly.

Co-Investment Fund

Some GPs establish a dedicated co-investment fund (an LPF or Cayman limited partnership) alongside the main fund to pool co-investment capital from multiple investors. This structure allows for efficient capital deployment across multiple co-investments while maintaining a collective investment vehicle with its own governance framework.

Key Contractual Documents

Co-Investment Agreement

The co-investment agreement (or co-investment letter agreement) sets out the terms on which the co-investor participates in the investment. Key provisions include:

• Investment amount and form: The amount to be invested, the instrument (ordinary shares, preference shares, convertible notes), and the price
• Fees and carry: Whether management fees and carried interest apply, and at what rates (co-investments are typically fee-free or at reduced rates)
• Governance rights: Whether the co-investor has board representation or observer rights in the portfolio company
• Information rights: Periodic reporting obligations owed to the co-investor
• Exit provisions: Tag-along and drag-along rights, restrictions on transfer, and the co-investor's ability to exit independently of the fund
• Confidentiality: The co-investor's obligations regarding deal confidentiality

Co-Investment Commitment Letter or Side Letter

Where co-investment rights are granted in advance (e.g., as a right to co-invest on qualifying deals up to a specified amount), the terms are typically set out in a side letter to the main LPA or in a separate co-investment commitment letter. The side letter should specify the deal flow notification process, the co-investor's right to pass on individual deals, and the timeframe for making a co-investment decision.

Regulatory Considerations

Co-investment vehicles offered to investors in Hong Kong may need to comply with the SFC's regulatory requirements if they constitute collective investment schemes or securities. Key considerations include:

• Whether the co-investment SPV constitutes a collective investment scheme that must be authorised by the SFC before being offered to retail investors (note: professional investor exemptions may apply)
• Whether the GP managing the co-investment is licensed for Type 9 (asset management) regulated activity
• AML/KYC obligations for the co-investment vehicle in respect of its investors

For co-investments involving virtual assets or tokenised securities, additional VASP licensing considerations may apply.

Carried Interest and Tax

Where carried interest is charged on co-investments, the GP should ensure that the structure qualifies for the Hong Kong carried interest tax concession (if applicable). The concession's conditions—including the minimum investment period and the requirement for the fund to be managed from Hong Kong—should be reviewed in the context of the co-investment structure.

Conclusion

Co-investment arrangements are a sophisticated feature of the private equity market that offer significant benefits to both GPs and investors when properly structured. The legal documentation should be carefully negotiated to address fee economics, governance, exit rights, and regulatory compliance. Engaging experienced legal counsel at the outset ensures that co-investment arrangements are structured efficiently and in compliance with Hong Kong law.

Alan Wong LLP advises private equity managers and investors on co-investment structures, SPV formation, LPF and OFC documentation, and regulatory compliance in Hong Kong. Contact us to discuss your co-investment legal requirements.