In a year that has seen the amount of venture capital dwindle, billion-dollar funds have hit a record for the first half of 2022, according to PitchBook. While that’s good news for the big boys, it comes at a price for women- and diversity-led aspiring managers.
Limited partners (LPs) are overwhelmed with commitments in mega VC funds, making it harder for underrepresented emerging managers to raise money from institutional investors and family offices that can afford mega-funds’ high minimum investment commitments.
The dominance of mega-funds isn’t the best news for high net worth investors (HNWI) either. The minimum investments in these venture funds may be higher than what they are willing to invest. Newer and smaller funds — like those founded by women and diversity-led emerging managers — tend to outperform older and larger funds. However, these funds involve a higher level of risk. The general partners of these firms typically come from non-traditional venture backgrounds and require different criteria to evaluate them.
Why the fuss about SPVs?
Special Purpose Vehicles (SPVs) offer diverse, up-and-coming managers an additional opportunity to raise capital. SPVs have lower fees than venture funds, close deals faster, and distribute returns more quickly, making them attractive to aspiring female managers, angel groups, and investors to invest in startups.
Accordingly, the number of SPVs more than doubled between 2020 and 2021 on the state of the SPV in 2022 by Assure, a benchmark report based on the organizers and investors who used its platform. Organizers are individuals or companies that initiate the formation of an SPV, raise the underlying business, and pool capital from other individuals or companies for investment.
It should be noted that not all SPVs invest in startups, although the lion’s share do.
“It’s about 60%,” said Leslie Jump, managing director at Assure Analytics. Other SPVs are used to invest in art, crypto, oil wells, real estate, and other alternative assets.
SPVs typically have smaller investment commitments than venture funds, especially the large ones. This lower financial commitment may attract HWNI that are not currently investing in startups. Ultra-high net worth investors (UHNWI) — $30 million in investable assets — are more likely to have advisors advising on venture investing than investors with portfolios between $1 million and $29 million. UHNWI can also afford the high investment minimums that mega-funds have.
What are the benefits of SPVs?
SPVs offer more transparency than venture capital funds. SPVs invest in a single startup that you know in advance. Conversely, when you invest in a venture fund, you invest in an investment thesis rather than specific companies.
“Access is one of the most important components of any type of investment, especially for private markets and women,” said Leslie Jump, managing director at Assure Analytics. According to First Republic Bank’s Fundraising Best Practices for Emerging Managers, it can take emerging managers 19 months to successfully launch a fund. “Fees can range from $250,000 to $300,000. If you are a startup [first-time fund manager]you can’t afford that.”
SPVs may also have a lower minimum investment requirement. “The average minimum investment is $10,000,” Jump said. They are a more liquid investment than venture capital funds. “It typically takes 2.3 years to receive the first distribution from an SPV and 10, maybe even 12 years for a venture capital fund.”
SPVs enable aspiring managers to cost-effectively test venture capital fund concepts. In lean startup lingo, it can be used to create a Minimum Viable Product (MVP) to validate the premise for a fund. It offers investors a proof of concept.
SPVs are built for speed. “The median for an experienced SPV organizer is around 35 days,” Jump said. “That’s a month to put your capital to work versus a private fund, which can take a couple of years for your capital to work.”
The volatility of public markets is making it harder for micro funds – those with less than $50 million in assets – to raise capital to close their fund or launch their next fund. A fund that may have taken 18 months in recent years may now take two or three years, Jump commented.
Who uses them?
“SPVs are a great tool for aspiring managers looking to build a track record and increase overall AUM [assets under management]and build relationships with limited partners,” Jump said. “The SPV may even attract new investors who may want to invest in my fund.” A first-time or second-time micro-fund manager who has depleted his reserve capital could raise additional money to invest in outperforming portfolio companies.
Investors like it because they can better understand the futures fund’s strategies. Unlike a VC fund, you know the startup will be invested before you tie up any dollars, and the fees are lower.
Angel groups use SPVs. to. “It’s inexpensive and low-friction,” Jump said. The use of SPVs has increased significantly over the past two years Fishing groups and SPVs by Assure. Many use them to consolidate checks into a single line on a startup’s cap table or to streamline administration and accounting. Others use SPVs as a lower-cost structure for their angel funds.
Venture funds in California and New York overwhelmingly dominate startup investments. SPVs are raising more money outside of the top two venture markets.
While VC-backed companies have remained private longer, thousands of early contributors holding stock options and early investors are looking to capitalize. SPVs can provide liquidity by purchasing shares through events such as takeover bids or sourcing deals in the secondary market.
Private secondary markets allow shareholders to sell private company shares to willing buyers, but unlike the public stock market, this is not easy and not transparent. Private companies do not have the same reporting and regulatory requirements. However, that hasn’t stopped the secondary markets from growing rapidly.
“I think you’re going to see a lot of secondary deals as people try to rebalance their portfolios because of all the things that are going on,” Jump said.
How will you use SPVs?