If you haven’t heard of a fairly new twist on investing called special purpose vehicles (SPVs), you probably aren’t an institutional investor or a wealthy individual with direct ties to either a venture firm or a high-flying startup like Pinterest or Postmates.
But don’t worry if you’ve missed the opportunity to invest in one. Investors may find they weren’t worth the risk if valuations of so-called unicorns — some given “haircuts” recently by their mutual fund investors — start to slip more broadly.
The vehicles – essentially pop-up venture firms that come together quickly to make an investment in a single company – began surfacing around 2011, leading up to Facebook’s IPO, and they’ve been on the rise since. In April, the Wall Street Journal reported on several low-flying SPVs that have been used to connect investors with high-profile, still-private companies like the data analytics company Palantir Technologies and the grocery -delivery outfit Instacart.
Another company that has raised money via numerous SPVs is the digital scrapbooking company Pinterest. When it set out to raise more than $500 million earlier this year, the venture firm FirstMark Capital raised a $200 million for a SPV to help fund it. In 2014, Pinterest separately raised $131.1 million through two SPVs organized as Palma Investments by SV Angel, the seed-stage fund founded by renowned investor Ron Conway.
It’s no wonder that investors are drawn to the vehicles. In the case of Facebook, early access to the company produced big dividends for investors. Investor Chris Sacca similarly amassed an outsize stake in Twitter for investors Rizvi Traverse and J.P. Morgan by creating SPVs that paid off. (How richly depends on when they began cashing out. As of late September, Rizvi Traverse had sold more than 10 percent of the 15.6 percent of Twitter it owned at the time of its November 2013 IPO. Twitter’s shares peaked in January of 2014 at $69 per share; they’re now trading at roughly $26 apiece.)
Whether investors in newer SPVs will see such rewards remains a question mark – and there a lot of investors in newer SPVs.
“It’s a sign of the times,” says one money manager at a Southern California firm who works with roughly 60 wealthy families and has been presented with numerous opportunities to invest in SPVs. “It’s about access,” says this person, noting that it’s hard to say no to certain investments no matter the terms, though he has pushed back against some SPVs that have traditional fund-like costs – meaning they charge 2 percent in management fees and another 20 percent cut from any profits. (“We don’t think we should be paying management fees,” he says. “The VCs aren’t doing any extra work.”)
A San Francisco-based venture fund manager whose central fund is smaller than $10 million, says he has raised seven SPVs in the last 18 months that account for “significantly more” than his original fund. (He doesn’t charge management fees on the SPVs.)
“My LPs like them a lot,” he says. “People like to put $250,000 or $500,000 into your fund, but when they see these [unicorn companies], they have no problem writing a $1 million check into that company. It’s always one email, every time, and people want to deploy [their capital], just like that.”
An L.A-based venture fund cofounder who asked not to be named, argues that SPVs have grown a little too easy to put together, in fact.
Though this person has organized several SPVs himself, he says he has begun to see “people who are unqualified trying to partake and sell access in things that are grossly overpriced. It reminds me of greed at the top of the market ” in 2000, just before the first dot-com bubble collapsed.
Craig Dauchy, the head of the venture capital practice group at the law firm Cooley, says he hasn’t seen any unsophisticated investors participating in SPVs. “With our client base, we’re putting together SPVS with legitimate venture managers who have the opportunities to pull together syndicates for excess capacity in their deals, [meaning] more than their existing funds can take.”
Either way, Dauchy notes that risks and big rewards are simply the nature of the investments, and whether they are good or bad is in the eye of the beholder. “Some would say there’s too much money chasing unicorn deals, while some would say absolutely not; they should absolutely get more money,” he says.
In the meantime, everyone involved or watching the trend anticipates trouble if the market turns.
“The downside of SPVS is there will eventually will be there will be failure, and the failure will feel more like failure than with a fund,” says the San Francisco-based venture fund manager. “With a fund, you don’t feel the flameouts as much because you’re still counting on a winner or two. It’s, ‘I don’t care if you lose one as long as you make money for me overall.’ But if Instacart goes to zero and you get a K-1 [tax document] that says you lost millions of dollars, that’s going to hurt.”
Indeed, it’s a little hard to know what to do about SPVs at this point in the game, suggests Brian O’Malley, a general partner at Accel Partners. He says while Accel hasn’t done any SPVs yet, the concept of doing one hasn’t been ruled out either.
“The upside,” O’Malley says, is that “they can be simpler to pull together than other financing rounds, and a class of investors can get broader exposure to companies that they’re excited about.”
Still, while SPVs are a “great concept when the market is up and to the right, it can be scary, bringing LPs more directly into deals and taking fees or some kind of carry off that when things turn and go the other way,” he adds. “LPs as direct investors is kind of a mixed bag, and it can be real dangerous when things go south.”