Special Purpose by Bob Rosenberg

Much of my writing this year has been grounded in two hypotheses:

  1. The power balance in the startup business has changed (in the USA, which is 80% of the market for startup investment.  An effect here ripples across the world).  Money is no longer the short asset.  Good companies are increasingly valuable and in demand, so much so that VCs have to compete to be chosen to invest in a company.  
  2. The traditional VC business is facing competition from new types of funds, new types of collaborations between investors, and new funding vehicles.  The old boy network is being disrupted.  And the disruption is fully on display in the growth of special purpose vehicles (SPVs).

SPVs, often called SPEs (special purpose entities) or syndicates, are nothing new.  Designed to support risky enterprises (stand alone or within a company structure), SPVs aggregate investment dollars into a entity that has a single purpose, which is investing in the risky project.   The dollars can come from a variety of sources, including angels, corporates, crowd funding, family offices, and investment funds.  The funds are then invested and ownership stakes are managed through the SPV. 

Until recently, investing in startups has primarily been the province of the well-heeled.  Minimum investments in a VC fund can range from €250,000 – €1 million.  And most angel groups require minimum investments of at least €10,000 – €20,000 per deal.  A well-constructed portfolio of angel investments might total €250,000; if you’re committing 5% of your overall wealth to early-stage (read: risky) investments, you must have a net worth north of €5 million.  

Which is where SPVs come in.  For an investment of as little as €1,000, you can get a place at the table.

And there are benefits with SPVs beyond the low investment requirement.  Standard VC investments include a 2% management fee (20% over the 10-year life of a fund) and a 20% carry (the money that the VCs scrape off the top of the profits at the end of the fund’s life).  SPVs usually charge a one-time management fee of 7-7.5% and a 10% carry.  And because you’re not invested in a fund portfolio, you can structure a bespoke portfolio by investing in separate SPVs.

Last week I spoke with a good friend who runs a small fund.  The fund is creating an SPV side-car ‘angel’ fund which will accept investments of as small as €1,000.  The fund will be used by the VCs to provide pre-seed investments in companies they like but are too early for an A-round.  The angel fund will encourage more contact and support from the fund managers, and valuable early funds for product development or roll-out.  This angel SPV will take advantage of the VC’s due diligence and management expertise, as well as connections and warm introductions.  And in so doing the angel fund provides a roadmap to an A-round investment by the ‘big’ VC fund.   The angel SPV becomes a value-add for the VC’s ability to engage with – and invest in – promising companies.  The angel SPV distinguishes the big fund – and it expands the range of investors who can participate.

SPVs come with some limitations.  They are more bare bones than VCs who have investor management resources.  You’re probably not going to get a quarterly report, or special announcements.  Keeping up to date with your investments takes more effort, especially if you’re invested in several SPVs (meaning several companies).  And the lack of a portfolio structure makes SPV investments more like sports betting.  If the company goes belly up, you’ve lost your investment.

More and more US-based startups are using SPVs to fund their seed and A-round investments.  The young, aggressive VCs who want to roll up their sleeves are partnering in the SPVs, providing funding and resources.  Sometimes big funds can’t provide the level of attention, or the youthful perspective.  At least from an optics point of view, the big, established funds have lost some luster in a new world where startups have become the buyers in a buyer’s market.


Bob Rosenberg
Educator (Associate Professor) / Entrepreneur / Leader of angel
communities /Entrepreneur in residence at PorterShed
and BioExcel / Rarosenberg@gmail.com

 

 

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