Investing in startups can take up a few different forms.
There’s the individuals — primarily the founders of successful companies, and operators who have built products at scale — known as angel investors who put in their money into individual startups.
And there’s the more sought-after venture capital which pools in big money from folks that are uber rich, family offices and sovereign wealth funds to invest in a bunch of startups.
However, if you are familiar with the world of startups, you’d know that Special Purpose Vehicles or SPVs as they are commonly called, have become a popular way for startups to raise money from a clutch of investors.
What is a Special Purpose Vehicle?
In simple terms, an SPV is a legal entity created by a company for a specific purpose or project.
Before we get further, note that SPV is not unique to startup investing and has in fact, over decades, been used by companies to isolate certain assets, as well as to form joint ventures. Since these vehicles have their own specific assets and liabilities that don’t appear on the parent company’s balance sheet, any risk involved therefore doesn’t legally carry to the parent company either.
When it comes to startups, a syndicate of investors can create SPVs for every single startup that they invest in, allowing the syndicate members a chance to pick and choose where they would like their money to go.
How it all works
Typically formed as Limited Liability Companies (LLCs), SPVs have investors as members and all income is distributed as per their share in the vehicle.
Assume that the total money pooled from a clutch of investors was $1 million and you invested $100,000, you will have a 10% stake in what the eventual income is, notwithstanding the “carry” and management fees that the general partners or syndicate leads typically charge.
What’s Carry?
Short for Carried Interest, Carry is what a General Partner or Syndicate Lead, the decision maker when it comes to investing, stands to make off of any profits.
For example, if the carried interest for a deal is 20%, what that means is once the limited partners (those who invested) get their original investment amount back, 20% of the remaining profits will go to the GP.
Carry = 20% x (Total Income - Original Investment Amount)
Whatever remains is then distributed to the LPs as per percentage ownership.
Pros and Cons
The obvious con of investing via SPVs as compared to venture capital is that you are limiting the diversification of your portfolio. Venture Capital firms invest in a wide range of startups, hedging against the failure of one or more companies in the portfolio.
However, being part of an online syndicate solves for it to an extent as the syndicate lead brings in various deals, giving you a chance to invest a certain amount in different SPVs formed for different investments.
Additionally, investing through these vehicles also does not give you rights as an individual shareholder in the company, since the SPV itself is one entity with any and all shareholder rights.
There are obvious benefits too. Unlike angel investing or venture capital that may require significantly higher amounts of capital going out of your pocket, SPVs allow you to invest in small amounts in startups.
A single entry on the Cap Table
Founders are saved the headache of an increasingly complex cap table by raising capital through an SPV. They accept funds from a group of investors who no longer need to be added individually, but are instead represented through the vehicle used!