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Deal Sheet = The Top Startup Deals to Your Inbox Every Single Week

June Deal Sheet Recap:

• New Deals Shared = 20

• Early (Pre-seed to Series A) = 11

• Growth = 7

• Pre-IPO = 2

• Co-Investors in June included → Thrive Capital, Bessemer Venture Partners, a16z, Insight Partners, Blackrock, Craft Ventures, 8VC, Founders Fund, Lachy Groom,  IVP, NEA, Redpoint, Lux Capital, Mayfield, Social Capital, Coatue, Silver Lake, Correlation Ventures, Tiger Global, Fontinalis, General Catalyst, Scale Venture Partners, NYCA Partners, Album Ventures, Qualcomm Ventures, Jason Calacanis, Coelius Capital, Maven Ventures, Construct Capital, Soma Capital

• Syndicates that shared deals = 10

To get access to these deals at 10% carry you can sign up for Deal Sheet here or book a call to learn more!

Understanding GP Authority and LP Rights in SPVs

In this week's post we are going to explore what LPs are signing up for when they invest in an SPV and who is “calling the shots” on some of the key decisions that take place post investment. 

But first, let’s quickly recap on the main paths to liquidity for both LPs & GPs who invest in the private markets.

What are the different paths to liquidity?

1. IPO → the company goes public and the SPV manager distributes the cash proceeds and/or shares to LPs (they could hold on to the share post-IPO - something we’ll discuss further).

2. Acquisition → the company gets acquired and the SPV manager gets cash and/or stock of the acquiring company which gets distributed to LPs.

3. Secondary Sales → the SPV manager sells a portion or the entire SPV to another buyer and distributes proceeds back to LPs.

4. Company Buyback (similar to secondary sale) → the SPV manager sells a portion or the entire SPV back to the company and distributes proceeds to LPs.

Considering the examples above, which ones demonstrate significant decision-making authority for the SPV manager? In which cases does the SPV manager have genuine control over important financial or operational choices, rather than just carrying out predetermined actions?

Let’s explore!

1. IPO → IPO timing is primarily determined by the company itself, with input from its board of directors and investment bankers. SPV managers, unless they happen to be board members (which is rare), typically have no influence over this decision.

However, SPV managers do retain significant control over capital distribution post-IPO. Specifically:

• Timing: After the IPO lock-up period expires, the SPV manager decides when to distribute capital to investors. 

• Flexibility: While it's common practice for syndicate leads to distribute capital immediately after the lock-up period ends, this isn't mandatory.

• Decision-making authority: The responsibility and discretion for this decision lie solely with the syndicate lead or SPV manager.

• Potential impact: This timing decision can significantly affect investor returns, as stock prices may fluctuate considerably in the period following an IPO.

Decision Maker = Both Company (IPO timing) & SPV Manager (managing position and distribution of proceeds).

2. Acquisition → M&A is dictated completely by the company and/or board; upon acquisition, the syndicate lead distributes capital (or the fund admin will distribute capital). There is typically no decision making power from the SPV lead in a cash acquisition. In a stock acquisition, the syndicate lead will typically hold these shares until a liquidity event. 

Decision Maker = Portfolio Company (if the SPV lead is on the Board or a highly influential investor, they may have outsized input, but this is rare for an SPV GP) 

3. Secondary Sale → this decision is typically made by the SPV manager as they have the power to find a buyer and agree on price to sell a portion or all of the syndicate’s position and then ultimately distribute capital proceeds to LPs.

Decision Maker = SPV Manager

4. Company Buyback → this decision is typically made by the SPV manager on behalf of the syndicate directly with the portfolio company. Once they agree on a price to sell a portion or all of the syndicate, the SPV manager would then distribute capital proceeds to LPs.

Decision Maker = Both Company & SPV Manager

Investing in a Special Purpose Vehicle (SPV) involves committing capital to a specific deal, which differs significantly from traditional fund investments where fund managers select multiple opportunities. Nevertheless, the caliber of personnel managing the SPV remains crucial, as these GPs retain substantial decision-making authority. Post-investment, numerous critical decisions arise that can significantly impact outcomes.

Consequently, it is necessary for LPs to thoroughly understand their rights as well as the rights and decision-making powers granted to the General Partner (GP) for any investment vehicle they choose to participate in. This understanding will enable LPs to make more well informed decisions and set appropriate expectations for their SPV investments.

Why? 

Because when it comes to follow-on, pro-rata investments, pay to play rounds, IPO, selling secondary etc., these decisions will absolutely matter as an investor. You are really relying on the GP to make decisions with the best interest for LPs. To be clear, not every SPV is structured the exact same way, but understanding the basics is imperative. 

The rights of an SPV fund manager depend on the specific structure of the SPV and the governing documents. Here's a breakdown of some common rights they might have:

• Investment Management: The fund manager typically has the right to manage the investments held by the SPV according to the investment strategy outlined in the offering documents. This includes selecting assets, making investment decisions (i.e. taking pro-rata, participating in follow on rounds, making decisions on pay-to-play rounds, liquidating at IPO etc), and overseeing the portfolio/SPV.

• Day-to-Day Operations: The manager might have the authority to handle the day-to-day operations of the SPV, such as managing bank accounts, overseeing accounting and legal matters, and ensuring compliance with regulations. While this is true, the vast majority of syndicate leads (in our ecosystem) work with fund admin platforms (like Sydecar, AngelList, Carta) who are providing much of these day-to-day operations. 

• Distributions: The governing documents might grant the manager the right to determine how and when profits and returns are distributed to investors within the SPV. This is important as it relates to an IPO as many times the manager can decide if they want to liquidate the shares and distribute proceeds to LPs at that time or hold on to distribute later. 

• Voting Rights: In most cases, the manager might have voting rights on certain matters related to the SPV, but these rights might be limited depending on the structure and the agreements in place

To summarize, if you are an LP in an SPV, you are trusting the syndicate manager to act in your/the investors best interest. You are going to have very little say on what to do in any post investment scenario. If you have questions regarding what would happen at IPO or even just further understanding how a GP is thinking about future liquidation and/or decision making, I  always recommend reaching out to the GP to get their take. 

Follow-On, Pro-Rata & Pay-to-Play Rounds

Follow-on rounds can be crucial decisions for GPs as they are opportunities to lean into your winners and protect against your downside in underperforming investments. While follow-on opportunities should generally be approached as new investments, it’s important to consider that your LPs already have an existing stake in these businesses and depending on the state of the startup, that’s to be protected and thus considered in the deal eval process. LPs typically will not have any decision making power on whether to bring these opportunities to market, however if the GP decides to proceed with these investments, the LPs will have the decision making power on whether or not to double down etc.

Below, are the typical future fundraising rounds that will take place:

1. Follow-on investment → This is typically a new round that is raising at a higher valuation (assuming the company is performing well, and growing efficiently). At this point we’ve already been investors in the business, and have a better sense on if they’ve executed / performed to date. Opting out of these rounds or participating below pro-rata will dilute our ownership. And of course this can take place many times over (i.e. you invested in series A and there will be follow on rounds for series B, C, D, E etc.). It’s estimated that Seed investors will be diluted 50%-70% from Seed to IPO, so follow-on rounds are incredibly important if you (the LP) hope to maintain your ownership - this rests on the GP to take the deal to market, and on the LP to participate with capital. Both of those must take place for an LP to avoid dilution in SPVs. 

2. Pro-Rata → This is similar to a follow-on round; however with pro-rata rights, we contractually have the rights to take our entire pro-rata and avoid dilution in this new round. I’ll write another time about how contractually having pro-rata means less than it appears and that founder relationship is arguably just as if not far more important. By not participating in your pro-rata, your ownership will be diluted with the new capital injection. Dilution is inevitable as an early-stage investor, so it's important to plan for/understand that. Most Seed funds will take pro-rata in their best performing businesses in Seed+ and Series A rounds, but potentially not beyond that from their fund. If SPV GPs have good relationships with founders, they are typically aggressive in investing follow-on capital in most, if not every future round. 

3. Pay-to-Play →  A pay-to-play round in venture capital is a financing mechanism that incentivizes existing investors to participate in a new funding round for a company, typically when the company is struggling to raise capital. These rounds tend to be significantly more dilutive if you do not participate because the round can be a lifeline round where in order to not lose most of your ownership interest and/or your preference status, you need to invest, however it can vary a lot. Investors who choose not to participate face negative consequences, such as:

   • Significant dilution of ownership percentage

   • Conversion of preferred shares to common shares or a new class of preferred shares with reduced economic rights

   • Loss of preferential rights like anti-dilution protection, liquidation preferences, or special voting rights

   • And much more 

We previously put out a topic on why pay to play rounds are uniquely difficult for SPVs, more on that here. 

It’s important to understand that company success from round to round will vary and enthusiasm from LPs to double down and/or deploy additional capital into a company will vary as well. It is on the GP to look out for the best interest of the LPs to decide which investment opportunities should be brought forward to the syndicate to explore re-investing in.

A Few Stories/Examples of GP decision making

I've heard stories from LPs in my syndicate of other GPs selling an SPV (as a secondary transaction) they  participated in to another buyer. The LPs were upset because they felt the position was sold too quickly (under 18 months from the investment in this case) which disappointed some LPs and was not in line with their expectations, who believed these positions would be held until a liquidity event. Time will tell if that was a good or bad decision, but it happens, which is part of the reason it’s important to know and trust the Syndicate managers. 

I’ve seen scenarios where SPV’s were marked up substantially (10x+) with the GP opting to sell a portion of the shares to return 2x-4x capital to LPs while still keeping the majority of the SPV’s capital in the deal for future upside. 

Every scenario here is different but I (Alex) generally think this can be wise and good for LPs to realize some capital at a 2x-5x+ while keeping more capital for additional upside. Others may disagree, as the age old adage in venture has been to let your winners ride, but this may no longer be the case given 1) the speed to markups for companies and 2) speed of disruption (e.g. higher prevalence of unicorn companies returning minimal capital or going bankrupt). To state the obvious, the status and position of the company in these scenarios is extremely important but generally speaking it can be great to realize a return while keeping 50%+ of the SPV’s capital in the SPV for future upside. 

A scary example is when GPs who syndicate deals completely leave the ecosystem. If they are not involved and actively making future decisions on pro-rata and/or pay-to-play rounds etc., then who is? Nobody, and that’s the problem as that syndicate might miss out on crucial post-investment decisions/opportunities. 

Pay-to-Play rounds can be uniquely tough for syndicates. In these scenarios, you typically need to invest additional capital to keep your ownership in the business and these really only happen when the company is in a less than ideal financial / business situation. While the Company’s situation at the moment may not be great, these rounds can wipe out LP investment if they’re not evaluated/managed. Additionally, they can occasionally be a compelling investment opportunity  if capital can solve the company’s problems and/or there’s large warrants and other sweeteners to participating investors, among other scenarios.

The reality is, you never really know as it’s an investment in a company that desperately needs cash, but if the GP does not evaluate and/or bring this opportunity forward to existing (and new LPs) then the SPV manager is essentially forfeiting their ownership in the business and previous LPs in the SPV lose out on their ownership. That being said, completing pay-to-play rounds as a syndicate has proven to be extremely challenging.  

I’ve spent a lot of time in this post, highlighting the trust that goes into managers when an LP with limited rights invests in an SPV. To wrap up on a more positive note, I’ll leave you with a reminder of my take on the benefits SPVs provide to individuals investors/LPs.

Pros of SPVs for LPs

While there are many limitations to LPs participating in SPV’s I do think it’s important to hit on the Pro’s quickly as a reminder of the value/service syndicate leads brings to LPs in the ecosystem. This includes (see full article we previously wrote titled “The 5 Pros and 5 Cons of Investing in Syndicates” here):

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 where 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 details.

2. More deal flow without the work of sourcing deals & securing allocations →When investing in SPV’s, the SPV lead does all the work to 1) source the investment opportunity and 2) secure the allocation for her/his Limited Partners i.e. the LP does not need to do any of the work required to source the deal or secure the allocation.

3. The potential for better economics than a traditional fund → here is the comparison of what I typically see funds charging in terms of economics versus SPVs/Syndicates:

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

   2. - SPVs/Syndicates = 0% management fees and 20% carry

   3. In short, the carry is typically the same, but the fee’s will almost always be less or none at all for SPV’s; of course your losers don’t go against your winners as they would in a fund structure 

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. Most individual investors do not have access to be an LP in the Sequoia, Benchmark or Greylocks of the world. SPVs provide opportunities to invest alongside pretty much all of the VCs that exist out there

5. Returns Opportunity → 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.

If you enjoyed this article, feel free to view our prior articles on LP considerations: 

• Why You Should Discount a Syndicate Lead’s Performance

• The Misaligned Syndicate Incentive Structure

• Pay to Play Rounds - The Bane of the SPV

Last Money in is Powered by Sydecar

Sydecar empowers syndicate leads to manage their investments more effectively. Organize, manage, and engage your investor network effortlessly with Sydecar’s management and communication tools. Their platform also automates banking, compliance, contracts, tax, and reporting, freeing up syndicate leads to focus on securing deals and strengthening investor relations. Elevate your syndicate operations with Sydecar.

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✍️ Written by Zachary and Alex