How are SPVs Structured?

August, 2020

GP/LP Alignment

Any VC firm should consider several factors before structuring its SPV or sidecar entity to ensure alignment with all parties involved (i.e., the company requiring funding, the LPs involved and other external investors). The co-investment vehicle, first created and controlled by the GP, is typically set-up as an LLC or LP. The LP, who is allocated an investment minimum on a pro-rata basis (with a management fee and carried interest included), is granted full access to the company's (i.e., investment opportunity) database and due-diligence material. Although the GP will have already conducted preparatory work in understanding the opportunity and relative risks, LPs can follow-on and leverage the co-investors' expertise in scrutinizing the deal.

The costs borne by GPs and entity sponsors to maintain and monitor an SPV is usually embedded into a management fee. The GP's also collect a carried interest which may vary depending on the opportunity being considered. For instance, a standard carry would entail 20% following a 1x Return on Investment (ROI). Whilst structures can vary from a 0/0 to a 2/20, many LPs are motivated to compensate GPs for the provision of deal flow and ensure optimal investment outcomes. Family Offices, HNWIs and other institutional investors may want to get involved in the later funding rounds of a well-performing firm. Although several investors might prefer a direct opportunity and will not invest in SPVs due to stringent fee requirements, such arrangements can be dealmakers or breakers and must be amenable to all co-investors involved.

Pros and Cons

While SPVs and sidecars are gaining a lot of undivided attention due to their numerous benefits, they also have a few disadvantages. While we believe the pros outweigh the cons, nevertheless there are a few risks that investors must be aware of before committing capital.

Pros:

Increased Deal Flow

Many investors as well as family offices may have access to limited deal flow depending on their unique mandates and geographical preferences. However, an SPV arrangement via the right GP relationships will enable such firms to tap into investments that might suddenly deem attractive in markets, such as exponentially growing tech companies. Institutional investors might also want to add to their existing allocations in such sought after companies via SPVs.

Leveraging Expertise

As an investor on the cap table, an SPV sponsor/organizer is likely to have had a significant allocation in the company and maintain close relations with the firm's C-Suite, in addition to sharing passion for its vision and wider objectives. Therefore, co-investors and participants through the side-vehicle can rely on GP’s expertise as well as diligence procedures.

Isolating Risk

Rather than deploying capital into a commingled fund, LP's have the chance to place their funds into an SPV shop for a deal they like. A carefully and intricately designed SPV structure enables clientele to have single-stock exposure with lower investment minimums, thereby isolating potential risk. This will differ from the structure of a traditional fund whereby clients put their money in a blind pool, thus trusting the fund manager rather than the companies involved.

Cons:

Passive Investor Tag

An SPV organizer is likely to have developed a close relationship with the CEO as an investor and board member. This would mean that any follow-on investors are deemed "passive" and may not be able to have as much of a say in the company's management policies.

At OGCP, we believe in developing and cultivating excellent relationships with our co-investors. Over the years in our existence as a firm in the space, we operate with quality firms - many of whom will serve their role as SPV sponsors and set aside allocations in premium opportunities for us.

Conflict of Interest

Many LPs might wonder why a pro-rata opportunity is being offered by a VC in the first place if it appears too good to be true. Navigating through such a situation requires a great deal of trust and excellent working relationship between the VC and LP.

OGCP’s universe is inclusive of leading PE/VC firms, as well as other institutional investors, family offices and UNHWI’s. We utilize the Canal-Lock System (CLS) to drill down on opportunities and have nurtured great associations with some of the best in this business.