Creating and Managing Investment SPVs

What is a Special Purpose Vehicle (SPV)? #

A Special Purpose Vehicle (SPV) is a legal entity created for the purpose of holding a specific asset or group of assets, such as a single company's equity or debt. SPVs are commonly used in private investments, including early-stage venture capital, to bundle a group of investors into a single investment into a company and to separate the risks and rewards from investments in one company from other companies

How do SPVs work? #

SPVs are highly flexible vehicles for making investments. Typically formed as limited liability companies (LLCs) or limited partnerships, both of which are pass-through entities, meaning that the income and expenses of the SPV are "passed through" to the owners, or members, of the entity in proportion of their ownership.

SPVs are typically used to pool investors to make a single investment in a company, appearing as a single investor on the company's cap table. This structure offers simplicity to founders because it reduces the number of investors on a cap table and thus reduces administrative work and requirements. For investors, the structure means that the members of the SPV do not have direct voting or information rights, and have to depend on the general partner (GP) of the SPV to represent their interests. For many investors, this is an acceptable trade-off for access to investments sourced by GPs, often at lower minimum check sizes than would be required if they were investing directly into a company.

Angellist also offers Roll Up Vehicles, an SPV led by the founder of a company to help make it easier for founders to bring in accredited investors at smaller check sizes.

There are legal limits to how many investors can invest in an SPV depending on how much money the SPV raises, and the type of investment made by the SPV will determine the necessary investor accreditation of the SPV's members.

What is an SPV? by Angellist is a great primer on how SPVs are structured and used.

SPVs will have expenses to organize and maintain the SPV's entity, and can have management fees and carried interest costs, depending on the SPV's rules.

How are SPVs created and managed? #

A number of companies offer services to create and administer SPVs. Creating an SPV incurs the normal legal costs in creating LLCs or limited partnerships, as well as the annual filing and reporting requirements of the LLC and tax forms (K1s) to the limited partners of the SPV. Managing the legal requirements of an SPV can be difficult for a general partner that may create many SPVs over their investing career, and thus there are a number of platforms to handle the upfront and annual requirements.

A number of companies that manage SPVs for investors are highlighted at Fund Management, but popular platforms include: ^[1]

• Angellist
• Sydecar
• Vauban, owned by Carta
• Allocations
• Canopy
• Odin
• Syndicate, targeted for Web3 DAOs and investment clubs
• Fund admins, legal firms, accountants, manual options

How are the economics of SPVs modeled? #

Modeling the expected returns of a single SPV is straightforward, and can be done by modeling the amount invested and valuation of the investment, potential future investment rounds to understand dilution, graduation rates, and potential exit sizes to calculate expected value, gross and net multiple, and IRRs from the investment.

Modeling the aggregate performance of a number of SPVs involves a bit more effort. For a general partner that leads many investments through SPVs from a network of potential limited partners, called a syndicate lead, the goal is to model out the aggregate or average value of a number of SPV investments to understand the aggreate realized and expected performance of their investments. Modeling the performance of the known or average future investment is straightforward, and involves the same process as modeling the expected returns of a single SPV. However, for understanding the potential returns to the syndicate's limited partners, understanding how the waterfall works takes a bit more thinking.

In the Foresight venture capital fund models, the default assumption of the fund waterfall is a European "total fund" waterfall whereby the fund must return total called capital to-date before taking carried interest out of the fund's distributions to limited partners.

However, the default waterfall behavior can be changed through a dropdown on the Forecast sheet to selected either the American "deal by deal" waterfall or the SPV "no clawback" options; the SPV no clawback option is used to model an aggregation of SPVs where each deal is independent, meaning that the GP only needs to return capital on an individual investment - not the overall fund - to earn carried interest.

Therefore, for syndicate leads looking to use the Foresight venture capital fund models to model an aggregate of SPVs instead of a fund, simply change that waterfall option; and all other assumptions remain the same.

This structure calls out one of the cons to a limited partner investing in a number of SPVs instead of investing into a fund; all else being equal, the limited partner will earn less because the GP manager does not need to use capital from winners to pay off the losers.

As a simple math example, consider an LP that invests $50 into a fund (investing $10 per investment into 5 investments) v. an LP that invests into 5 SPVs at $10 per investment (total $50). All fees being equal, and assuming a 20% carry, if 3 of the investments return 5x gross and 2 of the investments return 0x, then both the fund and SPV will have total gross proceeds of 5 * 10 * 3 = $150, or 150 / 50 = 3x overall. The fund will charge 20% carry on (150 - 50), or the $100 gains after returning total invested capital, and LPs will receive 50 + 100 * (1 - 20%) = $130 in distributions, and GPs will earn $20 in carry. The SPV will charge 20% carry on (150 - 30), or the $120 gain on those investments, and LPs will receive 30 + 120 * (1 - 20%) = $126 in distributions, and GPs will earn (150 - 30) * 20% = $24 in carry. LPs in the fund earn a 130/50 or 2.6x net, whereas LPs in the SPVs earn 126/50, or 2.52x net. The difference in returns in this scenario comes only from the structure of the SPVs that separates the risks and rewards of each investment.

Obviously that's a simple example, and "all else being equal" rarely applies in venture, and there are other pros and cons for funds v. SPVs. But it's important for LPs and GPS to understand this economic difference between a fund and SPVs.

One additional complication is that any individual limited partner may have very different returns than the "average" limited partner across the syndicate's SPVs. Since investors will usually make different investment decisions on participating in the SPVs sponsored by the syndicate, the investments that limited partners make may vary widely, and thus the returns from their investments may vary widely. While all limited partners in a fund will see the same performance in their investments (on a relative basis, noting the absolute returns will vary based on the amount they invested in the fund), the limited partners participating in a syndicate across a number of SPVs can see very different performance based on what deals they decided to invest in.

Consider the previous example, but alter the assumption so that 2 investments still returned 0x, 1 returned 10x, 1 returned 4x, and 1 returned 1x, for a total of 10 * 10 + 10 * 4 + 10 * 1 = $150 in total. If this was a fund, all investors would earn the same 2.6x net after carry. If this was a series of SPVs, the investor that invested in each deal would get the same 2.52x net as before; but consider an investor that invested in the 2 0x and 1 4x return, they would earn an overall 4 / 3 = 1.33x (before carry), but an investor that did 1 0x, 1 10x and 1 1x would earn an overall 11 / 3 = 3.67x (before carry). Varying the investments increases an investors' variability in investment performance, and while it can result in higher than average returns, it can also have the opposite effect on limited partner perforance.