A new report on seed investments in hedge funds, private equity funds, and other investment vehicles shows such transactions returning to pre-pandemic levels even in the face of challenging market conditions. The ninth annual Seward & Kissel Seed Transactions Deal Points Study, an analysis of 2022 seed investments produced by the leading law firm to the private fund industry, revealed surprising resilience in seed activity, which approached 2019 levels last year despite negative forces in the broader economy that included rising interest rates and the underwater status of many investment portfolios. The study can be found here.

The report attributes the uptick in seeding activity to one primary source: the increased seeding of traditional private equity funds and other illiquid or “closed-end” fund structures. Seward & Kissel observes that interest in less-liquid investment products have been on the rise in recent years, accounting for a growing share of seed activity. The report notes that based on current trends, it “would not be surprising” if private equity seeding ultimately equaled or even exceeded the hedge fund category, which for the time being still accounts for most seed deals.

Some deal points for seed investments, which give new funds and managers a foundation to attract additional investors, remained consistent with past years despite the economic uncertainty in 2022. The market-standard “lock-up” period—which limits seed investors’ ability to redeem capital and allows managers to orient their decisions toward the long-term—remained at a two- to three-year term.

The study also suggests an increase in both “manager-friendly” and “third-party investor-friendly” structures for seed deals. Seed investors showed a willingness to bear some start-up costs for managers and subject themselves to liquidity restrictions imposed on other investors after their lock-up period. However, the study also shows that seed investors sought protections to manage risks of market downturns and volatility, often negotiating performance-related lock-up release triggers.

Other key findings of the Seward & Kissel Seed Transactions Deal Points Study include:

• Investments in “hybrid” strategies, including positions in illiquid private companies, experienced a slight decline, likely reflecting the pullback in the tech and life science industries, two sectors in which private, illiquid investments have been significant historically.
• In 2022, 64% of deals included working capital support, up from 59% in 2021 and 41% five years ago.
• Traditional long/short equity strategies, particularly those with defined industry or thematic focuses, remained significant in terms of share of aggregate seed investment dollars.
• Digital asset strategies, multi-strategy managers, and event-driven strategies also accounted for a notable portion of the dataset.
• ESG-focused strategies remained a popular target of seeding activity, with a particular emphasis on diversity, equity, and inclusion factors.

Commentary:

Seward & Kissel Business Transactions Group partner Gary Anderson, the lead author of the Seward & Kissel Seed Transactions Deal Points Study:

“The continued increase in private equity seeding is extremely interesting, as economic conditions have not dissuaded investors from seeking opportunities in the private credit space, and we foresee a possibility where private equity seeding could eventually equal or surpass the hedge fund category.”

“The data reflects a resilient market despite the economic slowdown in 2022, which managers and investors will surely leverage to navigate evolving challenges in the years to come.”

Gary Anderson is available to speak to the media about the Seward & Kissel Seed Transactions Deal Points Study.

About Seward & Kissel LLP

Seward & Kissel LLP, founded in 1890, is a leading U.S. law firm with an international reputation for excellence. The firm is particularly well known for its hedge fund and investment management work, having established the first hedge fund ever, A.W. Jones, in 1949, and having earned numerous best in class awards over the years. In addition, Preqin recently identified Seward & Kissel as the top U.S. law firm based on number of hedge funds serviced.

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