To SPV or Not to SPV — That May No Longer Be the Question

In 2016, the Sapphire Ventures team wrote a great post (“To SPV or not to SPV”) on the pros and cons of special purpose vehicles (SPVs). Although that post included many sentiments that were commonly voiced by limited partners (LPs) at the time, it’s important to recall that SPVs were still relatively rare. Six years and a bull startup cycle later, both the use cases and sentiments around SPVs have evolved dramatically.

Today, SPVs are woven into the fabric of how funds are managed and firms are built — whether you’re a syndicate lead, a rolling fund manager, a solo capitalist or an emerging manager. Here are some of the ways we’re seeing emerging managers use SPVs to their benefit in 2022, as well as some important considerations associated with these strategies.

SPV Strategy #1: Use SPVs to build a track record before you have a fund

Emerging Manager A does not yet have a fund but secures a $100,000 allocation into a $1 million pre-seed round and puts together an SPV to fund the allocation. They then repeat this process 20 more times over the course of two years for other startups at similar stages, building a track record (and hopefully a handful of markups) before going out to raise for a true fund.

Benefits of this strategy:

• Demonstrates your ability to secure allocation into target deals
• Shows future LPs your sourcing strategy and conviction in action
• Builds relationships with smaller LPs whom you can tap into when you’re ready for the full fund
• Creates a portfolio of founders who can attest to your involvement and investing style

• The syndicate market is becoming increasingly crowded. It’s not unusual for some LPs to see the same deal from multiple syndicates, so it has become even more important to stand out to access the best deals
• SPVs and fund economics are vastly different. If your future fund strategy will be to lead checks, LPs will view your SPV lead role as less comparable than an at-scale investment you led elsewhere
• Maintain appropriate alignment with your syndicate. While there are numerous strategies for both carry and management fees with syndicated deals, it’s important to think through the implications of the strategy you select

SPV Strategy #2: Leverage SPVs to maintain pro-rata rights

Emerging Manager B has a $5 million fund and has invested $100,000 into a pre-seed startup. They have also been granted pro-rata rights for the next round. To maintain the same ownership percentage, they syndicate the allocation through an SPV instead of through the fund.

• Can provide protection against dilution from other investors when your fund size or reserves strategy will not allow for a follow-on check at the amount required
• Creates an opportunity for interested LPs to invest alongside the fund directly

• Carefully consider your portfolio fund model. Depending on your strategy, you may miss out on a lot of potential upside by sharing the pro-rata with others. We’re seeing an increasing number of opportunity funds being raised by emerging managers to maintain a larger percentage of their pro-rata through their own fund dollars
• Be aware of the potential for asymmetry among parts of the LP base. This part of the Sapphire Ventures post still rings true: “LPs want clearly defined terms in the [limited partnership agreement (LPA)] on how pro-rata offerings will work”
• Be alert for adverse selection bias. If the fund sometimes funds pro-rata itself and sometimes shares it with the LP base, LPs naturally wonder if they have equitable access to the portfolio winners
• Consider the potential for cumbersome LP fees if LPs are charged management fees on both the fund and deal basis

SPV Strategy #3: Strategic co-investment opportunities

Emerging Manager C has invested in the pre-seed and seed rounds of a promising startup. At the end of Series A, the founder offers additional allocation. The manager puts together an SPV to offer both LPs and a diverse pool of operators and angels who work alongside the fund, in keeping with a diversity rider.

• Can provide access to the cap table for a wider pool of investors who can leverage the fund manager’s investment expertise
• Can provide the founder with additional capital while maintaining a streamlined process through a trusted investor

• As with SPV Strategy #2, be aware of the LPA implications of sharing direct investment opportunities with some of your LPs, rather than all of them
• This can be a time-intensive and complex process for a manager who is primarily focused on deploying their own vehicle

SPV Strategy #4: Using SPVs to fund the purchase of secondaries

Emerging Manager D has a top-performing portfolio company that is nearing a large liquidity event. The manager’s role with the company creates an opportunity to purchase sponsored secondary shares from the company’s employees. The manager uses an SPV for this transaction instead of the fund’s capital.

• Given the liquidity in the private market today, these secondary purchases can be a good way to use leverage to yield high returns
• This part of the market is often inaccessible, so as an early investor this route allows you a rare opportunity to take part in a proven portfolio winner

• These SPVs tend to be highly complex and require a substantial amount of legal oversight given the short nature of the purchase. They are also the most likely to be audited
• They can create complex and time-intensive processes, especially when juggling the role of an emerging manager, who is primarily responsible for creating outsized returns for the core fund

As the number of strategies available to execute SPVs has grown, so has the number of investor-facing tools that make SPVs possible. SaaS providers like Flow, in which SVB is an investor, are making it easier to execute and scale SPV strategies flexibly. As these tools continue to develop, emerging managers are likely to refine these strategies further, as well as find additional ways to leverage them to create shared alpha.

Written by:

	Natalie Fratto Managing Director, Emerging Manager Practice at SVB
	Brendan Marshall Co-Founder and CEO, Flow