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Institutions are Coming for Your SPVs

In this week's post, we'll explore how institutional capital and family offices typically leverage Special Purpose Vehicles (SPVs) in their operations.

For traditional institutional venture funds, managing SPVs is generally not the core part of their business. These funds raise capital from investors with the expectation of deploying that capital at their discretion into deals that are in line with their fund criteria and targeted portfolio construction. When they identify an investment opportunity, they invest directly from the fund. This is contrary to the capital-raising process associated with SPVs, where the manager sources the deal first and then fundraises. 

However, there are a few scenarios where traditional venture funds would invest via a SPV:

1. Follow-On Investments 

Let’s say a fund led company A’s Seed round. Let’s assume the company is doing well and 1-2 years later that same company raised a priced Series A round at 2-3x the valuation of the Seed. In this scenario, most of the time, the fund that led the Series A round will have pro-rata and assuming they continue to believe in the company, will take their pro-rata and reinvest into this Series A. This fund would typically have reserves for this Series A round knowing they will follow on to X% of their companies they lead at Seed. To be clear, it's unlikely they would run a SPV in this Series A round and rather maintain their ownership via fund allocated capital. .

Enter Series B. Let’s assume the company is continuing to accelerate and another 1-2 years have passed, and they now have a terms sheet to raise a Series B at 2-3x the valuation of the Series A. In this scenario, the Seed fund that led the Seed and invested their pro-rata in the Series A, may not have additional capital in their fund to invest in this Series B. But what happens if they are still bullish on the company and want to continue to invest? 

This Series B round is a great example of where an institutional fund might put together an SPV. At this stage, the fund knows the founders of the company extremely well with the founders likely open to reserving an allocation for this Seed fund to increase their stake or perhaps they have pro-rata in this round.

This is a somewhat common scenario where this Seed fund may go out to their existing LPs and present an opportunity for direct deal access to add to their position in this business. It’s likely the Seed fund doesn’t have follow-on reserves earmarked for Series B rounds, so a direct co-investment SPV from fund LPs makes sense as the vehicle to continue to support the company. 

A buzzy example of this would be Menlo reported to be raising a $500M SPV to invest directly into their portfolio company, Anthropic. More on that here. Menlo recently raised a reported $1.3 Billion fund, so this is a great example of where billion dollar institutional funds still leverage access to invest via a SPV.

2. Allocation Beyond Fund Commitment 

Let’s stick with an earlier stage example here, but make it real. We invested in Betr’s first institutional round, their Series A, a few years back. The round was led by Florida Funders as the team had known Joey Levy well and were investors in his previous company. They clearly had a lot of conviction in Joey and the Betr business at this pre-launch state.

Now they already had a fund, but given their relationship and the larger capital raise taking place, they had an opportunity to invest more via a SPV. So, in this scenario, they ended up investing out of their dedicated fund but also took the initiative to raise an SPV likely from their existing LPs and perhaps others in the network that wanted direct exposure to Betr. 

Zach has a Rolling Fund and I run a small micro fund. We both will typically invest via an SPV on top of the investment we make via our funds. We’re not institutional investors, but a similar strategy applies to many emerging managers, and we are seeing this happening more and more, especially as new platforms like Sydecar have emerged to make running an SPV easier than ever. 

The Early Days of Partnerships across Emerging Fund Managers & Institutional Capital/Pro-Rata-as-a-Service Platforms

We are just now starting to see various partnership models come to market where we’ve got larger institutional investors partnering up with emerging managers typically investing early-stage. The emerging managers are typically investing at earlier stages of the company lifecycle (pre series A) and to no surprise have:

1. Good founder relationships ahead of series B or later stage rounds and 

2. Breakout portfolio companies that later investors want to get better access & insight into (in advance)

MDSV Capital & Sydecar just recently announced their Capital Extension Program as a way for emerging fund managers (and syndicate leads) to team up with MDSV and access a larger capital pool to invest as follow-on capital for their most successful portfolio companies. 

Specifically, Fund or syndicate managers who are accepted into the Capital Extension Program can access up to $5MM in available funds for follow-on investments into their best portfolio companies. This gives managers a chance to maintain or grow their ownership in companies that they took an early bet on and maximize their returns. All deals in the Capital Extension Program are run on Sydecar’s automated SPV platform. 

The CEP is available for investments into Series A through Series D stage companies with $12M or more in annual recurring revenue and a predictable revenue growth rate of 1.5X or more annually.

The Last Money In team was able to connect with Michael Downing, Founding Partner MDSV Capital who is also the point of contact for the Capital Extension Program. See below for more of his thoughts on the industry evolution and new partnership!

Last Money In: Any general thoughts on how things have evolved over recent years in MDSV’s interest to access direct deals? 

MD: We've started relying more heavily on our emerging manager network (funds we've invested in) for access to direct investments.

Last Money In: Are your direct investments typically sourced via emerging managers you’ve backed or elsewhere?

MD: It's gone from 30% sourced from Emerging Manager Funds( EMF's) to 80% sourced from EMFs in recent years, the added insights and background with MGMNT are invaluable.

Last Money In: What are scenarios where you would invest/participate in SPVs (i.e. follow on, additional allocation etc)?

MD: Now the Capital Extension Program is our most common direct. An emerging manager brings us a deal they wrote the first check into, gets us up to speed and we concentrate more capital into a Series-A, Series-B and split the carry with the manager.

Last Money In: What excites you about your recently announced partnership with Sydecar?

MD: we’re more excited about the EMF//Syndicate lead ecosystem than ever and Sydecar provides us with a unique entry point, since we’ve observed that the majority of quality emerging fund and syndicate managers are leveraging their platform.  In this current innovation super cycle, we believe EMF’s/Syndicate leads will play a bigger role than ever, we’re excited to help give them superpowers to do more and create more value in their portfolios.

In addition to this MDSV Capital/Sydecar partnership, we’ve seen companies like SignalRank emerge as well. SignalRank launched in 2021 with a “Pro-rata-as-a-service” offering, automating follow-on financing for seed managers in their fastest-growing companies. 

They are hyper focused on building a systematic investment platform with access to top tier startups at series B. Here is how they thinking about 1) Selection 2) Access and 3) Returns:

1. Selection: SignalRank is a live model trained on 50m+ data points from 1m+ fundraising rounds to select the highest potential series Bs.

2. Access: They invest in these series Bs via the pro-rata of their partners, seed investors who use their platform to fund qualifying follow-ons.

3. Returns: c.30% of SignalRank selected companies attracted a $1b+ valuation in their backtest (less than 10% in the overall market)

Read below from Rob Hodgkinson (SignalRank Founder/CEO) on why they launched the offering!

Rob: We launched SignalRank to support seed managers in maintaining ownership from Series B onwards in their highest potential portfolio companies. Seed managers are leaving significant value on the table by not financing their pro rata positions in their winners, due to:

• Capital scarcity: 99% of seed managers do not have an opportunity fund, so they do not have sufficient reserve capital to defend their positions; seed managers are only investing in an average of 1.2 rounds into their unicorns.  LPs are also sensitive to strategy drift with GPs committing too much capital to reserve financings.

• LPs fail to exercise co-investment rights: every LP asks for co-investment rights but very few are set up to diligence specific opportunities and even fewer can move quick enough to participate in competitive Series Bs. Chasing LPs can be time-consuming.

• Follow-on financing impacts core fund IRR: following on into your portfolio tends to reduce IRR because of larger check sizes with lower multiples at later stages. Our model aims to protect our seed managers' core IRRs.

SignalRank offers Pro Rata As A Service as an automated supply of capital with a streamlined process and favorable economics to 200+ seed managers to support their pro rata in qualifying Series B rounds.

The Offering: 

• Automated capital: supplied directly from our balance sheet; no capital calls or investment committees to slow down process; investment amount currently capped at the lower of $1m or our partner's pro rata, this amount will grow as our balance sheet capital increases.

• Streamlined process: we handle all initial and ongoing SPV setup and admin; we can move through our entire process from partner allocation request to funding in 5 business days; no need to engage directly with company management teams or repeat diligence. We typically just need to see the cap table, Series B term sheet, Series B fundraising deck & latest financials.

• Favorable economics: 20% of all upside on the investment goes directly to our partners, structured in deal by deal SPVs

In Summary…

As we continue to see more emerging managers raising funds to invest in early-stage founders, I’d expect to see more products & services to help them with more institutional capital pools partnering with emerging fund managers in unique ways to access their breakout companies, leverage their larger capital bases, and partner on economics. 

If you are supporting emerging fund managers with tools/services, we’d love to hear from you and learn more!

If you liked this article, feel free to view our past articles on VC structures. 

• Pay to Play Rounds - The Bane of the SPV

• Balaji’s New 506(c) Fund → Massive Step in Democratizing Venture Capital

• 📈How Investing in Bridge Rounds Landed Us Multiple 10x+ Returns

Last Money In is Powered by Sydecar

Sydecar is a frictionless deal execution platform for emerging venture investors. We make it easy for anyone to launch SPVs and funds in minutes, with automated banking, compliance, contracts, tax, and reporting so that customers can focus on making deals and building relationships.

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✍️ Written by Zachary and Alex