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⚖️ The 5 Pros & 5 Cons of Investing in SPVs ⚖️

This week we wanted to be SUPER CLEAR on both the pros and cons of investing in Special Purpose Vehicles (SPVs).

This is what we write about on a weekly basis, therefore we thought it would be helpful to break down all the major pros and cons, to provide clarity to all.

Before we jump in, let’s quickly define what an SPV is and how it works:

1. SPVs are typically formed as limited liability companies (LLCs) or limited partnerships. In either case, SPVs are so-called “pass-through vehicles”—they're owned by their members and pass through income (or losses) to those members in proportion to each member’s ownership.

2. When an LP invests in an SPV they become a “member of the SPV and in return for their capital, LPs receive “membership interest” in the SPV. Example: an LP who invests $10k into an SPV that ends up raising a total of $100k will receive 10% membership interest in the SPV.

3. Once an SPV has finished raising capital, it makes a single investment in a startup, sending a single wire to the company. The SPV will appear as a single entry on the company’s cap table.

Okay, now, let’s get into what SPV’s can offer investors, but also the drawbacks.

Pros of Investing in SPVs

1. Deal-by-deal decision making & low barrier to entry

One of the best things SPVs offer investors is the ability to invest on a deal by deal basis. This is very different from a traditional venture fund. In a traditional venture fund, you invest in the fund manager/GP who will allocate the capital accordingly to future portfolio companies. In SPVs, the investor can decide based on the deal, founders, opportunity, market, traction, valuation etc. if they do want to participate in the deal or not, and if so, how much they would like to allocate.

By investing in SPVs, LPs will often have a much lower minimum requirement to invest and get exposure to a particular deal versus a traditional fund. SPV’s typically have a $1k to $5k minimum. It’s typical for Funds to have minimums closer to $50,000, and for larger funds well over $1M.

SPVs are almost always going to be a lower barrier approach to put modest capital to work into a given vehicle. We view this as a big positive as it will allow for a broader range of investors to access venture capital opportunities.

2. More deal flow without the work of sourcing & securing allocations

When investing in SPV’s, the SPV lead/manager does all the work to 1) source the investment opportunity and 2) secure the allocation for her/his Limited Partners (note, LPs are investors in the syndicate). The role of the limited partner here is much less intensive as they are simply presented with the deal opportunity to review & diligence to land on a go or no-go decision on investment. The LP does not need to do any of the work required to source the deal and secure the allocation, therefore LPs have the opportunity to access everything through their syndicate leads.

For this reason above, I do think that backing syndicates and participating in their deals is the best entrance to venture capital for those interested to get involved but do not yet have high-quality deal flow. It allows you to capitalize on others deal flow and only commit capital when you are bullish on an opportunity. It’s also an amazing way to ramp deal flow, compare deals, and learn through repetition. Zach and I both did this (S/O to Jason Calicanis for me)!

3. Typically better economics than a traditional fund

Here is the comparison of what I typically see funds charging in terms of economics versus SPVs/Syndicates:

• Funds = 2% management fee annually across 10 years, so 20% in management fees in total and 20% carry

• SPVs/Syndicates = 0% management fees and 20% carry

In short, the carry is typically the same, but the fee’s will almost always be less or none at all for SPV’s (excluding setup costs which are a 1-time payment that range from $4k to $10k typically).

For additional context, it’s not that I don’t think management fees make sense. I do. I charge the exact same on my micro fund and they are justified when you have a team and pay salaries and are an institutional-grade fund.

BUT!

The reality is that SPV’s are typically going to have better economics if we simply compare management fees and carry side by side for a traditional fund versus a traditional SPV. In short, your dollar gets stretched further in a SPV versus a fund.

Quick note: we didn’t talk about diversification here, which I will get to.

4. Access to invest alongside Tier 1 VCs

SPV’s are a great way to co-invest alongside some of the best traditional venture funds who have either been around for years or are new to the scene.

Most individual investors do not have access to be an LP in the Sequoia, Benchmark, Greylocks, NEAs of the world. SPVs provide opportunities to invest alongside all of the VCs that exist out there. SPVs are popular enough by now, that it’s safe to say multiple SPVs have literally invested alongside every single top VC in the world.

This does not mean that particular deal will work out by any means, but many folks do like investing alongside those who have great historical track records and have built long-lasting venture capital brands.

SPV’s frequently provide access to invest-with-the-best!

5. Large returns opportunity

There’s many different strategies to diversifying your investments as an angel/LP. My partner Zach wrote a great post you can read here.

Venture capital as an asset class is typically riskier than others, however the upside potential is also much larger. We wrote about this weeks ago, but by creating a diversified portfolio of high risk investments, early stage VCs more or less accept that the majority of their portfolio companies will fail or return 0-1x capital back, but the few that make it will become massive winners, providing outlier returns of 100-500x+ invested capital and return the fund, potentially many times over.

Regardless of your strategy, it’s the 100x opportunities that allow for upside in a way most other asset classes cannot.

Some data from AngelList to support:

As of April 2023, “the AngelList platform has generated returns, net of fees, of 26.5% per year for investors (LPs) dating back to 2013. One might presume, then, that the typical AngelList startup investment returns 26.5% per year, with some variance. As such, investing in lots of startups (i.e., having a larger total portfolio) could be a good approach because it might lower the variance of returns in the portfolio.” Additionally, venture is a high-risk/high-reward asset class with returns uncorrelated to returns from other asset classes with the return potential for venture is among the highest of all asset classes.

Cons of Investing in SPVs

1. Can lack diversification (unless individual LPs diversify across many SPVs)

We talked about the Pros above and how there is more upside for investors when they invest in a winner SPV. That’s very hard to find and the vast majority of deals are certainly not winners.

When you invest in a SPV, and it loses, that investment goes to zero, and there are no other companies (like there would be in a fund) that can help you make money elsewhere and generate a ROI. If you diversify across many SPV’s, then you may achieve diversification, but on a deal-by-deal basis, if the SPV goes to zero, your investment goes to zero alongside it. And that’s unfortunately it, money lost 🙁

2. LPs pay carry

While this is similar to a traditional (without the management fees) fund, LPs do pay a fee for the access to a given deal. This is standard as the GPs need to be incentivized to put together these deal, however LPs will typically pay 20% carry which means they give up 20% of their upside in a given deal, but only after their principal is returned.

3. Private markets lack transparency vc. public markets

The reporting of information in private companies is not regulated nor public in the way it is for public companies. For that reason, the level of information varies by company and by founder. One company might send investors updates on a monthly basis whereas another might not share anything for over a year.

In short, as a LP in a SPV, you will not have full transparency into the company.

4. Lack of control

As a passive investor in an SPV, you have limited control over the management and decision-making of the investments. Your ability to influence the direction of the startups is minimal and when it comes to the potential decision of when to sell and liquidate you are essentially along for the ride and at the discretion of the GP.

5. Illiquidity

Venture investments are highly illiquid and can take years to generate returns, if at all. It can be challenging to access your capital before an exit event like an IPO or acquisition. Similar to the above, once you invest, you are essentially along for the ride and are not the decision maker of when you can liquidate.

Exit timelines for startups are uncertain and can be longer than expected. It may take many years before you see a return on your investment.

Disclaimer

Before investing in a Venture Capital SPV, it's crucial to conduct thorough due diligence, understand the track record of the managers, assess the risk tolerance of your portfolio, and ensure that your investment goals align with the long-term, illiquid nature of venture capital investments. Additionally, you should consider consulting with a financial advisor who specializes in venture capital investments to make informed decisions based on your specific financial situation and goals.

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Sydecar is a frictionless deal execution platform for emerging venture investors. We make it easy for anyone to launch SPVs and funds in minutes, with automated banking, compliance, contracts, tax, and reporting so that customers can focus on making deals and building relationships.

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✍️ Written by Alex and Zachary