Introduction
As was the case across nearly all other industries and sectors, the emergence of the COVID-19 pandemic and related global, national and local responses played an outsized role in the number and nature of seed investments throughout 2020. While activity during the first several months of 2020 was broadly consistent with 2019 trends, the effects of the international lock-down at the end of the first quarter of 2020 provided both promise and peril for historical seed investors, as the return of extreme market volatility reminded allocators of the attractiveness of portfolio exposure to hedged investment products, while the unknowns of how the pandemic would be resolved highlighted the risk of a rapid loss of a seed investment if the markets took a downward trajectory.
While fewer in number, investments in traditional long/short and macro strategies remained a significant portion of overall observed seeding activity (particularly in terms of their share of the aggregate dollars invested in seed investments). Credit focused strategies also remained popular with seeders (as has been the case over the last several years). In addition, “hybrid” structures – whose investment portfolios can often include significant exposure to illiquid positions (i.e., an exposure level well in excess of traditional “side pocketing”) – attracted a number of seed investments.
As in prior years, strategies that are more resistant to fee compression were in high demand, as were strategies that were able to provide favorable liquidity to their investors. While the 2019 dataset suggested an increase in investor level gates in seeded strategies (with seed investment liquidity oriented accordingly), this concept was less prevalent in observed 2020 transactions. Regardless, terms largely tracked prior years.
With capital raising during the COVID-19 pandemic being a unique challenge for new funds, managers who were able to obtain a seed investment had a considerable head start for their businesses and a springboard to attract additional investors. The persistence of two-year (and longer) lock-ups as the market standard incentivized seeded managers to invest greater resources in their businesses and orient their decisions – both investment and operational – with an eye towards the long-term.
Our 2020 data suggest that the core economic terms of seed deals continue to reflect a trend toward more “manager-friendly” structures; two key continuing trends are seeders’ willingness to (i) bear some of the start-up costs of the new business, and (ii) remain subject to a liquidity profile (post-lock-up) that is similar to other investors in the fund. However, seed investors also sought to include additional protections to manage the risk of unknown market conditions as the pandemic evolved and against the potential re-emergence of significant volatility – these protections were often expressed in narrower performance-related early lock-up release triggers.
Our 2020 dataset is both somewhat smaller than prior years and more concentrated with institutional seeders, with a concentrated subset of these seed investors representing a majority of the observations. As a result, our 2020 observations skew somewhat towards terms appropriate for seeders of this type. Nonetheless, most of the leadership and innovation in the last decade of seeding terms has been driven by institutional seeders, and therefore we believe our 2020 dataset remains representative of the state of the marketplace for seed investment transactions in 2020.
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