20/10/2010 Author: Tony Griffiths

The HFMWeek Seeding Top 5

Seeding capital, always the lifeblood of new launches, is now at more of a premium than ever, putting those firms that do have money to deploy in a position to drive the industry forward like never before. HFMWeek surveys the biggest active seeders in the space, and looks at what their next moves will be...

Start-up hedge funds have faced an uphill struggle of late. When the likes of Pierre-Henri Flamand, the Goldman Sachs prop star expected to roll out the year’s biggest new fund, is seen regularly downgrading his expectations for seed capital and pushing back his launch date, you know the road ahead is steeper than normal. High-quality investment is at a spectacular premium and new talent, desperate for long-term commitment, is the last in line to receive it.

On the flip side, with start-ups gasping for air, those that can provide the oxygen find themselves in a privileged position. “It’s a wonderful time to be in the seed business,” says Ted Seides, founder and managing principle of fund of hedge funds (FoHF) and seed specialist Protégé Partners. “The supply of available capital from seeders is dwarfed by the high quality of talented people coming out of hedge funds and prop desks. We have been doing this for eight years, and the opportunity set is as good as it’s ever been.”

It isn’t hard find to similar sentiments among Protégé’s peers. Patric de Gentile-Williams, COO at FCA, calls the sector’s current potential “tremendous,” while Raymond Nolte, who recently moved to SkyBridge Capital during the firm’s acquisition of the Citigroup seeding business, expects an “extremely attractive” pool of talent to continue expanding.

“The biggest difficulty right now is gauging the investor demand to lock up capital,” Nolte explains. “If you’re going to go out and seed someone, you need two- or three-year commitments and not everyone is comfortable with that right now.” There is a clear “supply/demand imbalance” in the market, he says.   

The consensus is simple – seeding opportunities are rife, but, like the start-ups themselves, the challenge is in finding the long-term capital to invest in them. What makes this Catch-22 so appetising – and helps marry the incongruous pairing of excitement and obstruction – is that those on the list have survived because they have already had some degree of success and, as de Gentile-Williams puts it, because “competition in the space is still relatively low”.  

HFMWeek could only find a handful of seeders still active. Among them, big, institutional names like Blackstone, Larch Lane and Protégé, and a few smaller operations such as Revere Capital Advisors and Erste Bank. Man Group’s RMF platform, an established presence, recently put its activity on hold.

As well as the participants featured in the top five, a number of other firms – absent due to a mixture of size and scale of involvement – are rumoured to be at various stages of activity. New Yorkers CYAN Management and Stride Capital are believed to be raising capital for seed investments, while Reservoir Capital and the Carlyle Group are both thought to be returning to the sector after a period of absence.   

In terms of the platforms themselves, structure is a key differential and dictates the services on offer. While the term ‘seeder’ is used as a catch-all, it traditionally describes those firms that provide seed capital and advice only, such as FCA. Those that provide capital and hands-on business development, and potentially distribution, are classed as incubators. As mentioned previously, Protégé is relatively unique in that it is structured as a FoHF, without a pool of capital dedicated to seeding. Erste Bank’s unit operates purely on prop money, though seeding head Guy Wengraf told HFMWeek he harbours ambitions to create a dedicated vehicle in 2011. It, like Protégé, operates without a dedicated pool of seed capital.

There are two pillars to all seeding platforms: manager selection and advisory; and a third, distribution, which is only available from some and divides opinion. At FCA, “manager selection is the be-all and end-all”, with emphasis on leveraging parent company FRM’s analysts. Advice is given when required, and investor relationships levered also, but official distribution is not. The stance is similar at Protégé: “We decidedly try to seed an entrepreneur who wants to run their own business,” says Seides. “We will offer guidance where appropriate to help them succeed, but at the end of the day, it is their business to own and run, not ours.”

SkyBridge and Revere, for example, are much more involved, offering distribution, marketing and general business development. “It’s not enough to give someone a cheque and wish them luck, you’ve got to help them build their business,” says Revere’s Nick McEwen. The two contrasting business philosophies – hands on or hands off – represent the key divide in seeding culture and is often embodied in the respective seeder/incubator labels.  

Unsurprisingly, most seeders are on the look out for more dry powder. Early this year, Blackstone launched its second seeding fund with a rumoured $500m and has plans to grow it to over $1bn. FCA has also had success raising capital this year, de Gentile-Williams confirms, while Swedish bank SEB became a rare new entrant in April, with $300m to spend. In May, Revere revealed plans to raise $150m, taking the unusual step of offering a 25% stake in itself in return for a “strategic partner”.  

Those seeders that do have capital to put to work have, due to the environmental pressures on the start-up community, more power at the negotiating table. “That’s one of the differences in the space,” says Nolte. “As a seeder, you can get better terms than you could pre-crisis.” One of the big shifts here has been in the economics – top line revenue shares in particular. Pre-crisis, securing 25% was seen as extremely attractive to a seeder, with 10% or 15% typical. In today’s environment, 30% is not uncommon, Nolte says. Other firms will take an equity share in their seeds.

Dutch seed platform IMQubator, meanwhile, has prospered with the unique requirement that a seed relocates a significant portion of its management team to its Amsterdam offices – a demand no doubt aided by the reduction in available, institutional-quality capital.  

Other traits of contemporary deals include: buy-out multiples, giving a seed greater scope and incentive to be successful and buy itself out via a multiple of a period’s revenue; drawdown triggers, designed to kick in if a manager struggles to raise assets, which started appearing pre-crisis and is now more prevalent; and liquidity triggers. Other triggers remain popular, such as key-man clauses, net and gross fund, sector, position exposure limits, concentration limits, and other investment guidelines.

A few of the basics in deal structuring have remained relatively constant. There appears to be an industry standard of two to three years for lock ups (although Larch Lane prefers three to five), while capacity varies from firm to firm but remains similar to the pre-crisis range. SkyBridge, for example, will consider funds with capacity as low as $200m, while Revere requires a minimum of $750m. Almost all firms, however, ensure there is an element of flexibility to their deals and rule out very few traits on principle.  

The typical industry ticket size, for obvious reasons, has dropped slightly in recent months – where once it wasn’t uncommon for the average to be between $75m and $100m, now it is $25m to $50m. In fact, IMQubator has a well-documented standard ticket of €25m ($35.25m). There are a couple of notable exceptions: Larch Lane, who, pre-crisis, averaged tickets of $20m, has, following its joint-venture with PineBridge Investments, upped the stakes to an average of $75m average, while Blackstone has maintained its $100m average since inception and regularly stretches to $150m.

The small community of seeders is not without new additions: Stride Capital, a new venture from former SkyBridge principle Don Rogers, debuted in February, while April saw the launch of both SEB’s Manager Catalyst Fund and Reyl Asset Management’s Irish-based fund of funds; an FRM-backed project acting effectively as a conduit for FCA. As history has shown, however, the current crop of names is at risk of rapid and wholesale change and the biggest success stories still tend to be found at big names – the institutional brand investors. “Probably the most valuable thing a manager gets is the signalling value,” explains de Gentile-Williams. “They want the money, which pays their fees and their costs, but the reality is that it gives them momentum in asset gathering.”

A good reference or public support from the likes of FRM-backed FCA, Blackstone, or, more recently, APG-backed IMQubator is worth its weight in gold, and bodes well for the likes of SEB. The opportunities currently available may drive success for many, but next year’s list is likely to be similarly focused on big names with large, reputable sponsors.

Click on the links below to find out more about the top five HFMWeek seeders:

5. FRM Capital Advisors (FCA)
    - Allocated capital: $290m
    - Unallocated capital: $150m

4. Larch Lane Advisors
    - Allocated capital: $715m
    - Unallocated capital: $105m

3. Skybridge Capital
    - Allocated capital: $745m
    - Unallocated capital: $50m

2. Protégé Partners
    - Allocated capital: $1.05bn
    - Unallocated capital: n/a

1. Blackstone Strategic Alliance Advisors
    - Allocated capital: $1.1bn
    - Unallocated capital: $500m