Do Fund Concession Funding Rounds Work?

When I’ve spoken with several institutional investors and family offices at various industry events, our discussions have inevitably turned to “concession funding rounds” for Hedge Funds. And often I hear the same thing: “Why should I be the first investor in? On many levels, it’s only natural for Limited Partners to wonder why they would want to be the seed capital into a newly organize investment fund. At the same time, there are some misperceptions about concession funding rounds that are worth sorting out. Consider the following:

The fund sponsor has put in all the work. They’ve assumed all early-stage costs, as well as execution, and fund organizational cost risk. Why would they then offer early-stage investors the ability to participate in the GP’s success by giving concessions?

Newly organized funds will generally have a plan to reward their early-stage investors into their funds. In doing so their goal is actually twofold. They want to reward those first movers but they also want to be able to report higher ROIs, in an effort to attract additional down-line investors due to the fund’s momentum and higher investment returns paid based on the concessions they end up giving.

Concessions don’t mean they are giving it away for free. Investing is all about measuring and taking risks and the market adjusted rewards investors expect to receive on that risk. This, in many ways, is the defining ethos of investing, which is why so many sponsors balk at the practice of giving concessions away on the first money into their funds. Though many equate it to investor handouts, it helps them attract more downline investors thereby creating economies of scale lowering the funds costs for everyone.

Pride of ownership creates more enterprise value. Sometimes when you buy a new car, you’ll take extra notice of others on the road who drive the same one. In some cases, they may give you an appreciative nod or even a wave, almost as if they want to revel in the experience of ownership with you.

On a much grander scale, especially with new Fund Sponsors, the same thing holds true within the institutional investor community. When other prominent investors become the fund’s limited partners, a much stronger sense of pride, validation, and shared responsibilities for fund success begins to emerge.

Naturally, the structure of certain fund concession programs could be a huge component of that LP’s success. When Institutional investors, and in many cases, key family offices do better, they credit their successes at a much greater pace than the subsequent fund investors. This does mean Fund Sponsors have added pressure, based on maintaining their momentum, and are motivated to perform at even higher levels for their downline investors. Another factor is human nature. Most people want to be a part of something emerging and larger than themselves and to rally around a common cause, which can be even more prevalent when there is a new product or investment thesis as in the Case of our Tri-Party Venture Funds®, whose interest has seemed to captivate many mainstream institutional investors.

Considering both the financial and intrinsic rewards associated with concession funding rounds, it makes sense that the most efficient and professionally run fund sponsors are the ones that offer it. Accordingly, firms that share their rewards with their early investors also tend to have higher performance and loftier NAVs—all of which benefit fund sponsors.

Nearly 30 years ago, the Red Hot Chili Peppers sang, “Give it away, give it away, give it away now.” When confronted with the prospect of granting a concession to early-stage investors, that is what many successful sponsors think about, when planning concessions the conundrum be damned.

Yet, what fund sponsors need to realize is that concession rounds aren’t about giving it away. Just as often, it’s about what they can gain: a structure that rewards the first movers and illustrates performance attracts others, creates economies of scale, boosts value, and helps to ensure they will enjoy the rewards associated with the initial sweat equity they’ve put in and fortifies the underwriting.    

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