At a basic level, venture capital success comes down to the quality of sourcing, selection, access, value-add, and the exit. The latter two aspects are perennial differentiators that will likely remain important drivers of success. However, in a funding universe that has dramatically expanded – to more and deeper pocketed VCs, as well as to angels, micro funds, incubators, and advisors – early sourcing and selection no longer guarantee access.
One key question, then, for venture capitalists is: if the best prospects are highly sought after by many funding sources, how do I get into tomorrow’s leaders?
The answer is “access,” which now seems to be more important than ever. In a start-up’s early days, investors and advisors who are already on board may have played a critical role in its success and have an opportunity to become a preferred cap table choice for CEOs and founders.
All that is needed now is capital to monetize this opportunity, which is where the special purpose vehicle (“SPV”), funded by limited partners, comes into play.
When is an SPV appropriate?
Venture capital SPVs are entities created for Series A, B and later financing rounds, round extensions, secondary purchases and other investment opportunities. Their capitalization may be as little as a few hundred thousand dollars or more than $50 million, depending on round size, company stage, and access level. In some cases, the amount is determined by an angel investor’s pro-rata amount. Alternatively, it may reflect an informal co-investment privilege granted by a founder to early investors and advisors as a token of appreciation or way of keeping them meaningfully engaged – or both.
Whatever the case, this sort of vehicle allows venture opportunities to be monetized, even in those circumstances where an SPV manager oversees one or more of its own funds. This is especially true where the latter entities do not have sufficient capital available for the investment in question or where there is no real fit strategy-wise.
That said, there are a number of things worth bearing in mind. Putting together an SPV entails a fiduciary duty as well as a commitment to managing the vehicle. There are also a variety of reporting, legal, tax, audit and accounting requirements, though much of the work is done at inception, typically in a matter of days, and incorporates a healthy dose of boilerplate limited-liability-entity language.
Company perspective on SPVs
Fast-growing businesses are increasingly open to having venture capital SPVs, managed by a trusted partner, early investor or some other individual who played a key role in the firm’s formative years, included in their cap table. In fact, by facilitating this option for those whose efforts have already proved critical, the company stands to benefit from the simplicity of having one less VC relationship and/or one less board member to contend with. Sophisticated SPV LPs may also be able to support future financings, make VC and customer introductions, and provide market insights.
Finding the right SPV Investor
One key to success when it comes to embracing the SPV approach is to work with one or more LPs who can act quickly, efficiently and flexibly, and who also have access to follow-on capital. In a highly competitive VC environment, where companies often receive multiple term sheets and rapidly close rounds, an SPV investment opportunity window may only be open for a few weeks – or less.
It also makes sense to bring LPs into the fold as early as possible – that is, well before a final term sheet is accepted. This helps ensure that the SPV manager obtains sufficient access early in the process and the investor has sufficient time to evaluate the opportunity. Experience suggests that the process is iterative, involving frequent communication and other interactions as terms and allocations are finalized. To ensure the investor does not face any last-minute surprises, it is important for the manager to highlight key strengths and weaknesses early and often.
Final word on the benefit of SPVs
Aside from the economic benefits of managing SPVs, this sort of vehicle can also strengthen relationships with underlying LPs and institutionalize a manager’s activity. Once established, it may also serve as a conduit for other investments, or as a jumping-off point for separate but similar vehicles, which can enhance a track record for subsequent fundraising, if desired. Alternatively, if a manager already has early-stage wins in hand, later-stage SPV successes can prove helpful if a decision is made to launch dedicated growth funds.