In recent years, equity ownership has fallen out of favor with seeders due in part to concerns over potential liability issues and increased regulatory scrutiny. Seeders receiving equity interests often look for additional transparency and control over the manager, but these rights can also be sought after by seeders through revenue-sharing contractual arrangements. As the seeder is participating in the net profits, it will be more involved in monitoring the manager’s expenses and will typically seek caps placed on the compensation paid to the manager’s principals and, sometimes, the employees. In these arrangements, the seeder receives its percentage share of the net profits of the manager and general partner and the net capital proceeds on a sale or IPO of the entities. In a smaller percentage of deals, seed capital participation can take the form of an equity-ownership interest in the manager and the general partner entities. This structure also protects the general partner from any restrictions on its ability to deduct any revenue share payments to the seeder with respect to the seeder’s share of the carry/incentive allocation. The seeder receives its share of the carry or incentive allocation as an allocation of the fund’s income to the seeder’s capital account in the fund, which allows the seeder to receive the same long-term capital gain treatment (if applicable) to which the general partner would otherwise be entitled on such income. However, some seeders are willing to bear certain expenses of the manager or to structure the revenue share to kick in only once the manager has received a threshold amount of revenue over a designated period to ensure the manager has enough capital to cover its operating costs.įor tax reasons, the seeder in a revenue sharing arrangement typically participates in the carried interest or incentive allocation received by the general partner of the funds advised by the seeded manager through a special limited partner participation in the applicable master fund. Since the manager’s expenses do not reduce the seeder’s revenue participation, the seeder is not concerned with monitoring and measuring the manager’s expenses, so the manager can maintain more operational independence in this type of arrangement. The percentage share received by the seeder in a revenue sharing arrangement is typically lower than the percentage granted an equity arrangement as the seeder receives a share of the manager’s gross profits rather than its net profits after the deduction of expenses. Typically, a seeder is also entitled to a percentage of proceeds on a sale or initial public offering (IPO) of the manager and the general partner. A revenue sharing agreement is a contractual arrangement in which a seeder is entitled to receive a certain percentage (typically ranging from 15% to 25%) of the seeded manager’s gross or top-line revenues and of the carried interest or incentive allocation received by the general partner of the seeded fund. Seed capital arrangements most often take the form of a revenue sharing agreement between the seed capital provider and the manager of the fund in which the seeder is investing. Seed Capital – Revenue Sharing Arrangements. This article examines various structures for seed deals and how they compare to increasingly popular first loss capital arrangements and then explores the terms for participation rights and capital commitments of seed capital providers which are often subject to negotiation. First loss capital arrangements can provide an alternative means for managers looking to attain a critical mass of funds to start a track record but who may be hesitant to relinquish control over their businesses. A seed deal is essentially an agreement by an investor to invest an agreed (often significant) amount of capital in a manager’s fund for a locked-up period in exchange for participation in the manager’s business and/or certain other beneficial investment terms. Seed capital can provide the much needed critical mass of assets under management (AUM) from the outset of the fund to provide the manager with a working capital base to fund its operations and a means to attract other investors. With the increasing high costs of launching and managing a hedge or private equity fund, entering into a seed capital arrangement can provide a significant opportunity for an emerging manager to launch a successful fund or for an early stage manager to attract additional capital.
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