Seeding and Anchoring the Next Generation of Managers: Key Takeaways
Rebecca Springer, PE Analyst, PitchBook

Introduction

On October 21, more than 60 representatives from emerging and established firms, allocators, and service providers gathered at Long Arc Capital’s office in New York for a panel discussion sponsored by the New America Alliance and PitchBook on seeding and anchoring the next generation of managers. The New America Alliance is an organization whose leadership and members leverage their influence to increase capital access for women and minority-owned firms, and to accelerate diverse leadership in entrepreneurship, corporate America, and public service.  Four industry leaders offered candid insights on the seeding and anchoring landscape: Jeffry Brown, CEO, Azimut Alternative Capital Partners; Val Ivanson, Head of U.S. Manager Research, Stable Asset Management; Kirk Sims, Director and Head of Emerging Manager Program, Teacher Retirement System of Texas; and Alan Weinfeld, Partner, Invesco Private Capital. PitchBook’s Wylie Fernyhough, Lead PE Analyst, and Rebecca Springer, PE Analyst, moderated the discussion based on their recent report, Seeding and Anchoring Private Equity Managers.

Some of the key takeaways from the discussion are summarized below. In what follows, we define an “anchor” as a significant first-close commitment with discounted fees, while “seed” refers to a first-close commitment accompanied by a revenue share or GP- or fund-level stake that typically sunsets after approximately the first three funds. 

Evolution of the seeding and anchoring landscape

Seeding was first pioneered in the hedge fund world and has since moved into private equity and then other alternative asset classes. Today, seeding and anchoring is becoming a standalone asset class. The seeding and anchoring landscape has grown along with the growth in private markets more broadly; in particular, the explosive growth of venture capital is driving activity as seeding and anchoring permeates the venture fundraising world.

Private capital fundraising ($B) by asset class

Interest in seeding and anchoring has grown among LPs for numerous reasons. It goes without saying that seeding and anchoring offer attractive incremental returns to LPs by providing preferential economics in first-time funds, resulting in significant upside potential. But LPs also highly value the relationship-building potential of seeding or anchoring. The advantages of becoming a close, trusted partner to up-and-coming GPs are numerous. Seed or anchor LPs can secure access to small funds which may become oversubscribed in the future (especially venture or lower-middle-market funds) and, for managers with megafund ambitions, can ensure that the LP’s voice will still be heard on the LPAC even as the fund grows.

Another driver of the growth of seeding and anchoring has been the improvement of service provider support around these deals. There are now more law firms that understand seeding and more bankers doing GP advisory work. These service providers are often willing to work with first-time funds because it allows them to grow their client base by establishing relationships early on.

How traditional LPs and seeding firms differ in their approach to seeding or anchoring 

Traditional LPs and seeding firms approach seeding in different ways. The emerging managers program of a large pension fund will choose to back managers in part because of their long-term growth potential and market perception, as well as their interest in building an enduring relationship. They may also pass on some seed or anchor opportunities and instead make introductions to a seeding firm and look to commit to a subsequent fund. By contrast, seeding firms are more likely to act early and diligence managers with a view toward their performance over a longer period beyond the initial investment.

The role of diversity in seeding and anchoring

Every seed or anchor LP defines and approaches diversity differently. However, there was unanimous sentiment among panelists that a good seeding fund or emerging manager program should end up backing a diverse cohort of managers, both because of the diversity of the talent currently looking to fundraise – especially but not exclusively in venture capital – and because of the proven benefits of diversity in building and executing on a differentiated investment thesis. For LPs seeking to make a positive societal impact with their commitments, backing diverse managers can have a multiplier effect, since these managers are more likely to invest with diverse business owners.

Key risks in underwriting seed or anchor commitments 

Seed and anchor LPs must be comfortable with the reality that first-close, first-time fund commitments involve many unknowns, even after the most rigorous of due diligence processes. One key risk is the relatively high failure rate of emerging managers: for US private equity firms, about 1/3 of first-time funds do not raise a subsequent fund. Emerging manager failures are often due to unhealthy team dynamics or other personnel issues. Most founders of new firms are seasoned investment professionals, but lack experience building and running an organization. That said, seed and anchor LPs may still be willing to back managers who are open to making necessary governance changes. On the other hand, red flags that signal a lack of integrity – including in managing junior staff – can be a dealbreaker.

Number of US private equity buyout funds closed by fundraising outcome

LPs’ perspective on allocating to managers who have already taken a seed or anchor

As seeding and anchoring have become more common, LPs are increasingly willing to commit to managers who have already given up economics in their first fund. However, it is imperative that the manager understands and can clearly explain their seed or anchor deal and its rationale. Specifically, subsequent LPs will look for a seed or anchor where GP-LP interests are aligned and where the economics that were given up are commensurate with the value that the seed or anchor LP is providing. For this reason, the reputation of the seed or anchor group is extremely important. LPs will also want to closely examine the level of influence the seed or anchor LP has, including lock ups, voting rights, and the duration of the agreement.

Pitch deck pitfalls

When approaching LPs as a first-time fund, first impressions are key. Panelists offered advice – and cautionary tales – that focused on communicating a clear, differentiated story concisely and immediately. The pitch book itself should speak for itself and communicate the most important takeaways with just a five-minute read. The pitch should explicitly connect the team’s experience to what they are looking to do next and shouldn’t sugar coat past or expected challenges. Panelists also advised that LPs collaborate extensively and talk about the managers they are seeing in the market – so every meeting counts – and that would-be first-time managers may have to take hundreds of meetings in order to find the right seed or anchor LP.

The future of the seeding and anchoring

Our panelists foresee continued growth for seeding and anchoring across private markets. This will be driven by overall asset class growth, especially in private equity and venture capital, as well as continued de-stigmatization of taking seed or anchor capital. PitchBook data shows that even as private capital fundraising has increased overall in the last decade, emerging managers have accounted for a decreasing proportion of fund closes – meaning that more would-be new managers will be looking for the fundraising boost that a seed or anchor can provide. On the LP side, more large pensions are launching emerging manager programs, which helps solve some of the governance issues associated with investing with first-time funds and may open the door to increased seeding and anchoring activity.

Emerging manager fund closes as a proportion of funds closed by asset class

In the future, enterprising seed or anchor LPs may find ways to use predictive analytics to find and assess more diverse investment talent – including new managers with non-traditional resumes. The seeding and anchoring industry may also begin to see greater specialization, with different LPs focusing on backing managers in different asset classes that best match their risk-return appetite or on writing different check sizes. As mentioned previously, venture capital will continue to be a growth area for seeding as new managers from diverse backgrounds enter the fundraising market.

We look forward to continuing the conversations begun at this event as the seeding and anchoring landscape continues to evolve and mature.