What is an SPV? It’s a Special Purpose Vehicle (a legal entity set up for the purpose of making just one investment).
SPV’s are great ways to invest in stuff outside of a fund’s main thesis.
For us, we do SPV’s when we have hit a concentration limit within our fund, but want to keep allocating to a specific deal, or when investing in a company would be outside of our initial thesis.
SPV’s are also a great way to get started as a new investor. Raising money into an SPV is easier than raising money into a fund for the following reason:
· When an LP invests into an SPV, all they have to decide is whether or not they like the deal you are showing them.
· But when an LP invests in a fund, they are putting capital into a blind pool, not sure what companies will be in it — so they have to believe in YOU.
The difference between raising money for an SPV vs. for a fund, is that in an SPV the investor is underwriting the asset (the thing you are about to invest in), whereas in a fund, they are underwriting YOU.
And if YOU do not yet have an investment track record, or a long-standing relationship with the person, a fund will be very difficult to raise for.
Many new managers have built their track records by raising SPV’s until their collection of investments gives them the track record and LP network they need to raise a dedicated fund.
SO — while SPV’s are becoming the vehicle of choice for emerging managers to prove themselves either on their own, or in the absence of porting a track record from a traditional fund, they can be a real pain.
Below are 8things I wish people had told me about SPV’s 4.5 years ago.
(1) Life is 25% investing, and 75% fundraising.
The best part of investing (for me), is when I find a deal and I see the unique insight, that most other people don’t see, and I have the “ah hah!” moment of (a) why the idea might work and (b) why I was uniquely positioned to get access to something unobvious.
80% of the time I know whether or not I want to invest within 10–15 minutes (pending diligence).
After that, if you do not have a blind-pool vehicle (a fund behind you), you have to immediately start putting together marketing materials, and hit the phones with all the people in your network who might be able to invest. The time spent raising money for SPV’s ends up taking more time than the diligence and sourcing does.
(2) It’s harder to have contrarian views
Each SPV needs to be raised one-by-one. Which means as soon as you like an investment idea, you have to convince at least some handful of people that they should like the idea too.
It’s hard to avoid the temptation in a meeting to start thinking, “I wonder if I could raise money for this?”
Much of investing is about believing in something other’s don’t like, and being right. But investing via SPV’s can turn into investing in stuff you know others will like, and that you’ll be able to raise for. (Investing in stuff you know others will like is a dangerous trap towards negative selection bias and/or high valuations).
Since the investors who fund our SPV’s have known us and invested with us for some time now, we can get over this hurdle (usually), but it’s hard.
(3) Allocations are always a pain. You either raise too much, or too little.
Any entrepreneur who has ever raised a syndicated round knows this too well. They go out to market, try to convince the whole world their company is a good idea, and either too few people like the investment, or too few do.
In the event that too many LP’s like it (which is hopefully the case if you’re good at syndicating SPV’s), you end up in an awkward place where 4 people ask you how much allocation is left at the same time, you tell each one there is $X amount left, they all say “yes,” and you have to go back to them and say “erm… sorry, but actually you went too slowly and only 1/4th of that amount is available.”
It’s crazy how pissed people get when this happens. Even worse, some say, “well, if it’s that little it’s not worth my time.” So you go back to the other three and change the number on them again, and it sounds awkward… and it’s just a pain.
(4) Reserving money for follow-on rounds
Many early stage VC investments are predicated on holding at least some dry powder in case the company starts to take off, or is struggling and needs a bit more capital to get to its next inflection point.
When investing out of a fund, it’s easier to reserve that capital and budget for it at the manager’s discretion. When raising for an SPV, you have to rely on the investors in your SPV to do the same.
No matter what these people tell you, they are not planning as well as you would (or at least not all of them), and the next time the company needs a follow on financing, getting a 100% follow on rate from the SPV investor base is nearly impossible (meaning you have to do a new fundraise to fill the gaps all over again).
(5) When you lose money on a deal — you’ve lost 100% of the capital
When managing a fund, you expect to have some winners and some losers. But when investing out of an SPV, if the company fails and for one of your investors this is the only deal they’ve done with you, YOU HAVE LOST 100% OF THAT PERSON’S MONEY.
Even though we invest in risky assets, losing 100% of someone’s money is one of the worst feelings in the entire world. And it’s very unlikely they invest with you again, no matter how experienced or warned they were.
(6) It’s hard to invest in your own firm’s growth
A dedicated fund has management fees that can be used to hire people, rent out an office, market the fund, etc. But SPV’s don’t put off recurring or guaranteed revenue. So if SPV’s are your full-time thing, you are basically building your business on lumpy transactional revenue — meaning you under-invest in growth, and stretch yourself thin.
Plus... the real money takes a ton of time to get to.
(7) Reporting is difficult and admin/audit/tax is harder
When managing a fund, it’s easy to report on a quarterly (or monthly) cadence to all of your investors, who all have the same exposure to the same companies.
But if you are managing 20 different SPV’s, with 20 different varieties of investors, you need to put together a huge set of different reports/email lists/cadences etc. This starts off manageable and then becomes insane to deal with.
Even worse is that often because SPV’s are small, you have to rely on less expensive law firms, admins, and accountants to provide services to the entities.
(Shout out to Alex Davie at Riggs Davie who does ours, and totally breaks this rule. He is THE BEST).
(8) Leaving money on the table
When an entrepreneur asks you how much you’d like to invest, it’s hard to predict how much you can raise until you start marketing the investment. We always low-ball the number so that we don’t get stuck in a position where we can’t fund an investment we’ve promised to make (NOT ALL INVESTORS DO THIS — ENTREPRENEURS SHOULD WATCH OUT FOR PEOPLE OVERPROMISING). But this also means that often we could have invested more/made more money if we had known what our capital base was from the beginning.
In any case — we’ve learned a lot about doing SPV’s in the last few years. We still use them, and have solved for a lot of the issues mentioned above — but they’re imperfect.
