Why Emerging Fund Managers Should Run a Hybrid Fund/SPV Strategy

In private markets there are two basic investment vehicle structures:

1. Single-Asset Vehicles = a pool of money that invests in one thing

2. Multi-Asset Vehicles = a pool of money that invests in multiple things

In the startup world these are known more generally as SPVs (“Special Purpose Vehicle”) and Funds.

• SPVs are created pool capital and deploy into a single investment opportunity. Classically used by Syndicates (like ours).

• Funds are raised to pool capital and deploy into a number of opportunities usually grouped around some sort of thesis or stage or both. Think big names like Sequoia and Benchmark.

It can be easy to think that funds are the “better” structure, because they’re associated with prestigious names, but there are actually pros and cons to each. There are certain things SPVs are better for than Funds. There are certain things that Funds are better for than SPVs.

In this post we’re going to breakdown each and talk about how it’s actually possible to have the best of both worlds.

The Pros and Cons of SPVs

We’re biased because this is the path we took, but as we’ve written about before: SPVs can be a great way to start out as a manager. The reason SPVs can be a great starting point is that they considerably reduce the barriers to capital deployment. Raising a Fund can take a long time - months or years. Raising an SPV for the right opportunity can be done in a few days.

This allows SPV leads to get to work building their track record right away. For context, between Riverside Ventures & Calm Ventures, we have completed over 130 SPVs in the last 12 months, which comes out to closing an SPV every 2-3 days.

The reason SPV raises can move so much faster is that they’re much easier to diligence than a Fund opportunity. SPVs are typically Single-Asset Vehicles so there’s only one underlying opportunity to make a decision about. This is very different from raising for a Fund where the underlying investments haven’t been decided on yet and will likely play out over the course of years.

An SPV investment is a bet on the startup. A Fund investment is a bet on the manager.

As an LP, SPVs can be a great way to get a-la-carte access to startups you’re interested in, rather than having to bet on a new manager. The minimum investment amounts for SPVs can also be as low as $1,000 whereas it’s typical for Funds to have minimums closer to $50,000, and for larger funds well over $1M

Another layer down on the manager side is a benefit that can equate to Millions: SPVs - and their outcomes - stand alone. Unlike a fund, they are not grouped with other investments. This means that the upside economics are distributed on your winners (20% carry for example) without being hindered by your losers.

What does that mean exactly for a GP?

If a syndicate GP invests $10,000 into 100 SPVs and 99 of those SPVs return 0 capital back but 1 returns 100x (or $1M back), then that GP will receive 20% carry on that entire 100x investment winner or $200,000, despite actually returning $0 in aggregate of his 100 SPVs. However, if a $1M fund invests $10,000 each in 100 companies (so $1M total), 99 of which go to zero, and 1 of which returns 100x, the VC fund will receive zero carry as his 99 losing investments of $10k each go against his one 100x winner that produced $1M. So the net is the fund only returned $1M total i.e. the funds principal investment, and as such, the GP receives $0 because no profit was produced by the fund.

However, this all gets a lot harder when markets are rocky. When things are good and confidence is high - SPVs can fill up fast. When things are bad and confidence is low - SPV investing is one of the first things to go. This is where Funds start to look more attractive.

The Pros and Cons of Funds

As mentioned before, Funds can be hard to get going. Unlike SPVs that focus on a single startup, Funds are deployed into multiple startups at the discretion of the manager - typically over the course of multiple years. In a lot of ways, Funds are just a bigger commitment from both the side of the LP and the Manager.

BUT

If you’re able to raise a Fund, there are a lot of benefits. The most notable of which being that when the manager decides to invest, the Fund invests the capital that is already there.

With SPVs, the lead can make a commitment to a startup, but ultimately the SPV lead is going to have to ask their LPs for the capital to fulfill that commitment. That can be a pain as the SPV lead does not know exactly how much capital they will be able to get from LPs and this sometimes creates friction from the founders and/or other investors in the round.

Another benefit of Funds are management fees. Technically, you can charge management fees on SPVs, but it’s less common within the syndicate ecosystem and sometimes frowned upon in the early stages. For Funds, management fees are standard and can give a manager the capital they need to support themselves investing full-time as well as hire a team.

The presence of management fees for Funds and their absence for SPVs is why you typically think of Funds as bigger operations and SPV leads (Syndicate leads) as small or even single-person part-time teams.

Finally, one of the biggest advantages of a Fund is market timing. As mentioned in the SPV section, when times get tough SPV investments typically slow down significantly. Historically though, the best time to invest are when times are tough! Funds are great for this.

The best funds deploy through tough times and have exits when the market cycles back up. This is where spending the time to raise a Fund can really pay off.

Best of Both Worlds

So how do you get the best of both worlds?

Looking back on the Pros and Cons of each structure, here’s what we suggest:

Starting with SPVs is the best way to build a track record. Similar to a Founder showing traction before they fundraise, SPVs can be a way to “show not tell” and get a manager moving.

Once you’ve established a track record, it’s time to go out and raise a Fund. It won’t be easy, but if you’ve been successful in your SPV investing this is worth the effort. It will give you the ability to move fast with Founders, support yourself and/or a team, and deploy through tough market conditions.

Here’s the trick though: As a Fund manager you don’t have to wave goodbye to all those SPV benefits. You can have both. And many who have started with SPVs, have moved on to do both.

It has become more and more common for Fund managers to invest out of their Fund and then to raise an SPV alongside that investment for the same startup. This allows Fund managers and LPs to experience the best of both worlds. Meanwhile, Founders are often happy to receive more capital from an investor they have already decided to bring onto the cap-table.

Fund managers are able to deploy quickly as well as earn deal-by-deal upside. LPs of the Fund get the a-la-carte benefits of SPVs if they decide to lean into a specific deal on top of their diversified Fund interest.

This may sound logistically complicated - and up until recently it was. Now though, with tools like Fund+ from Sydecar or the AngelList Fund suite - this structure is just a few clicks away. The opportunity has even led Sydecar to build functionality in Fund+ specifically for this use case, offering a co-invest feature with reduced fees and a single line item on the target company’s cap table. Both of us have successfully started as syndicates and now have fund products to go alongside them. We built these in a fraction of the time that would have otherwise been required if we started with a fund product before building a track record in SPVs.

As mentioned, these two products are very synergistic, allowing us to support LPs better by providing them with individual deals and/or a fund with reasonable minimums, founders by providing them more reliable capital, and ourselves (GPs) by providing us with both committed capital with management fees to deploy across macro environments and the ability to operate SPVs to add more capital into our best companies.

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✍️ Written by Alex and Zachary