Managers warned on giving early investors too generous terms
Launch hedge funds have been warned that granting too many concessions to early-stage investors could make them un-investable further down the line.
So desperate have some launch hedge funds become to attract initial capital, they are offering excessively favourable terms and conditions to early investors, which could alarm future prospective investors.
“It is a tough environment for hedge funds to raise money, and some managers are desperate to get the first batch of investors in the door that they are granting them highly generous, if not too generous transparency and liquidity terms. It is a trend I’ve been noticing and it can be off-putting to future investors, as they could argue the early-stage allocators could have an unfair advantage to redeem assets if the business runs into difficulty,” said Phillip Chapple, managing director at KB Associates, a boutique hedge fund consultancy in London.
Day one or early stage deals have become more prolific as seeders have quietened down or culled their activities - a J.P. Morgan capital introductions group survey revealed last year that 68% of investors would not provide seed capital. “Day one investors unlike seeders do not have equity in the manager, and are not locked in for a material period of time, which is why liquidity and transparency terms afforded to day one investors are sometimes frowned upon,” said Chapple
Regulators argue that all investors should be treated fairly. Nonetheless, some hedge funds and investors point out that early stage allocators are taking on more risk, and therefore should be entitled to better terms and conditions.
Chapple highlighted managers were in a bind. “The balance of power has shifted markedly from the manager towards the investor. If an early-stage investor offers $100 million to a manager, but on extremely onerous terms, it is likely to deter future investors. This effectively knee-caps a managers’ ability to grow their business, and if that investor then pulls their cash, the manager is in serious trouble,” he said.
Despite fees being a contentious issue for investors with a number of institutions exerting downward pressure on the traditional 2% management fee and 20% performance fee, favourable fee concessions to early stage allocators do not seem to be a major issue. “A lot of early stage investors, as they are taking the most risk, tend to be granted better fee terms, and this does not bother future investors. However, excessively generous liquidity and transparency terms to these early stage allocators, is a cause of contention,” commented Chapple.