Want to Invest Like a Venture Capitalist? Launch an SPV.
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Just as influencers can monetize their following through syndicated ads, tech investors can monetize their following through SPVs.
An SPV – short for special purpose vehicle – is a legal structure that investors use in a bunch of situations (from investing in classic cars to buying multi-unit apartment buildings). Startup investors care about SPVs because they can use them to broker a deal between startup founders who trust them and investors who want access to startup deals. By positioning themselves in the middle, SPV organizers get some of the financial return without having to invest their own money or launch a full-fledged VC fund.
As Patrick McKenzie aptly notes, SPVs act as “effectively, an extremely specialized one-use one-time computer program which pretends to be a company.”
SPVs allow you to convert more deal flow because founders prefer SPVs too. It’s simpler overhead for founders since the SPV treats multiple entities (angel investors) as a single line item on their cap table.
SPVs also enable you to market to a broader group of investors. SPVs allow high-net-worth individuals or family offices to invest on a deal-by-deal basis without having to do the work of sourcing the investment and doing the initial diligence. Oftentimes they’re more than happy to exchange a small fee or share the carry for this opportunity.
SPVs created a fundamental shift in the VC landscape, giving the power to those who have the best investment opportunities rather than those who have the most amount of capital from limited partners (LPs). In this new era, SPVs reward investors who have strong, helpful relationships with founders, which is how incentives should be aligned.
If you want to invest in startups, consider launching an SPV. This essay will talk about why you should use an SPV and how to set one up.
Note: if you’re considering allocating some of your portfolio to investing in startups, Compound can help. We’re a wealth management platform for tech founders, employees and investors. To get help with this decision, reach out here.
Why you should use an SPV
Say a friend comes to you with an opportunity to invest in their startup. You’ve been working alongside this friend for years now and you know that they are going to win in whatever they work on. You don’t want to miss out on this opportunity. But you don’t want to sell anything in your 401k to gather the capital to invest.
What can you do? Before, you had three options:
- Do nothing – this leaves you with no upside.
- Angel invest – an option only if you have the money.
- Launch a VC fund – this is a huge headache (and basically requires a career change).
SPVs are better than each one of these options for different reasons.
Compared to doing nothing, organizing an SPV allows you to earn upside in a company that you normally wouldn’t have been able to. They open up a new behavior – and a potential source of building wealth – for people with access to founders.
SPVs are also better than angel investing. You can actually invest! SPVs allow you to use other people’s capital instead of your own. This is a benefit both if you don’t have any money or if you don’t want to take money away from other investments.
And finally, SPVs are better than launching a full VC fund. These days, due to SPV automators like Carta, Assure, AngelList, etc., SPVs are cheaper (<$10k), faster (less than a week) and less effort (easy with tech platform) than VC funds. People will also utilize SPVs on the path to becoming full-time venture capitalists. It’s faster and cheaper to launch an SPV than to raise a fund. This enables you to build a track record before launching a full fund. Instead of starting from scratch, you’ve already been investing with the exact people who could become LPs in your fund.
How to set up an SPV
Setting up an SPV might be intimidating at first, but it’s actually not much work (especially with platforms like Assure). Here’s how to do it:
1. Earn allocation. The first step is to earn allocation in a startup investment. If you’re reading this article, you likely have the opportunity to do this already.
2. Pitch opportunity. The next step is to find the capital to invest in the startup. Provide your network with general information about the opportunity including the deal terms (amount raised, valuation) and reasons why you’re excited about the company. You should be very careful at this stage that you are only speaking with those who you have a prior relationship with so you do not run afoul of securities laws. We recommend asking your lawyer about “Rule 506.” That said,our goal is to get a “sense check” of the deal. Oftentimes an investment memo is a good way to communicate these reasons. This can be done through a distribution list where you send out deals to your network in order to streamline communication.
Your investors may ask a couple of clarifying questions about the business but it shouldn’t be too much additional work on your end – they know you have to move quickly.
3. Set up the SPV. Once you have enough investor interest to fill the allocation, set up the SPV. These mechanics are intuitive — just go to their website and follow the instructions. The main detail you’ll have to decide on is the terms for your SPV.
SPVs generally provide two broad buckets of fees you can charge: management fees (a percent of the capital) and/or carry fees (a percent of the returns). Typically, SPVs don’t have management fees (it's a one-time investment vehicle) but charge 10-20% of carry. Depending on your leverage among your network you might be able to charge higher amounts (you can learn more about the mechanics of carry here).
4. Raise capital. The final step is to raise the money from your investors (who you already knew before you started fundraising unless you want to qualify each of them as an accredited investor and change your securities qualification). They should already be interested from your previous conversations; this step is to finalize their wire transfer. You may have to send email follow-ups to some investors to get them to wire over the money as sometimes investors drag their feet on investing decisions.
Along the way, startup founders often provide monthly or quarterly updates to investors that include updates on the business and asks for investors. Remember that most startups fail, but you’re investing your time, and your investors are investing their money on the conviction that this one won’t. Carefully consider what you say and write about this SPV investment you are promoting so you do not later get sued for securities fraud should the investment fail. We recommend consulting an experienced securities lawyer before you raise capital.
If and when the startup reaches a liquidity event (likely years down the line), you and your investors will likely be paid out automatically. Platforms automate the distribution of capital so there isn’t usually much administrative work involved at the end.
Years ago, even SPVs were expensive and a hassle. But due to automation platforms like Assure, AngelList, Carta, Canopy, and others, it’s cheaper. Having a large amount of cash used to be the only way to invest in startups, but with SPVs anyone with a strong network can.
If anyone with access to tech deals has the power to become a venture capitalist, how will the investing landscape continue to change? More than ever, the competitive edge will continue to be getting access to the best founders.
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