Special Purpose Vehicles (SPV) For Early-Stage Startup Fundraising – How It Works

When structured strategically, Special Purpose Vehicles (SPV) for early-stage startup funding can be a valuable asset. An SPV is essentially a legal entity that allows several investors to pool their money and invest in a startup. These entities are different from syndicated investors and microfinance.

Early-stage startups can use this channel to raise funding and take advantage of its many benefits. Organizations create these separate legal entities for a specific objective, such as isolating risk. Most SPVs are structured as limited liability companies (LLCs).

Special Purpose Vehicles (SPV) are Gaining Traction in the US

The venture capital boom of 2021 triggered the exponential growth in SPVs in the US. They grew year-over-year at a rate of an astounding 235%. Statistics show that in the third quarter of 2024, close to 2442 Special Purpose Vehicles (SPVs) operated in the US.

The growth in the number of SPVs had undoubtedly slowed down since 2021, when investors formed 838 new vehicles. However, they continued to grow at 116% over the last five years. In 2016, SPVs on Carta managed an average of $1.18M in assets. But this figure rose to $2.17M by 2023.

Management fees are also rising significantly with the popularity of special-purpose vehicles. In 2021, 41% of the SPVs managing more than $10M in assets charged their members a fee. By 2023, 67% of SPVs were charging a management fee.

SPVs are independent, direct investment institutions with registered domiciles in the US. Most such vehicles are small. Between 2016 and 2023, close to 66% of the SPVs had an AUM of less than $5M. However, this segment is specifically geared toward backing early-stage startups.

Larger SVPs with an AUM of $50M and above comprise around 2.6% of the segment. However, they account for close to 30% of the funding startups raise. If you’re looking for funding for your startup, you can leverage both segments.

Understanding Special Purpose Vehicles for Early-Stage Startup Fundraising

Special Purpose Vehicles for early-stage startup fundraising are valuable channels since they can help limit the possible risks. By definition, an SPV is an independent legal entity created to fulfill a specific purpose.

Entrepreneurs can use them to structure their funding differently from conventional venture capital investment. SPVs have certain legal capabilities that allow you to close the funding deal quickly. You can also customize the terms and agreements to align with your company’s business model.

In certain aspects, special-purpose vehicles are similar to conventional venture capital funds. Both options allow you to raise funding from limited partners. However, while venture capitalists invest in a broad portfolio of viable companies, SPVs focus on a single asset–your company.

Typically, SPVs source their capital from smaller investors or limited partners and focus on fulfilling pre-determined objectives. They act as an intermediary between the company and its investors and allow them to pool their money for investment. This allows individual investors to minimize their risk.

Special purpose vehicles operate on a shorter timeframe than other funds. Particularly when the investment is successful, and delivers returns quickly. On the flip side, since the SPV invests in a single asset, the risk diversification benefit is lower.

All factors considered, special purpose vehicles for early-stage startup fundraising provide higher assurance to investors of getting repaid. As a result, raising capital is easier. You can also use this strategy to source funding from offshore investors so they can avoid U.S. tax filing requirements.

Fund Managers Run Special Purpose Vehicles

A fund manager, general partner, or “GP” heads the SPV and facilitates the limited partners in pooling money and investing in the startup. In a conventional venture capital (VC) fund, the GP identifies viable investment opportunities and creates a basket of different companies.

Limited partners in the VC fund can spread their investment and risk across multiple companies in the fund portfolio. However, if the limited partners wish to invest in a specific company, they set up a special-purpose vehicle.

Fund managers may set up SVCs for several reasons. For instance, if the fund doesn’t have adequate capital, the GP may deploy it to fill pro-rata applications. As a rule, VC funds have pre-determined investment criteria for evaluating potential funding candidates.

However, say a particular company does not fit the profile but is a viable investment. In that case, the GP may instead create an SVP to participate in its funding round. In this way, they can reach out to selected investors interested in backing the business concept.

You might think of the SVP as a specific compartment containing a company’s assets, risks, and money. This compartment is segregated from the central fund’s finances and thus helps isolate risk.

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How Special Purpose Vehicles Work

A sponsor or lead investor may set up an SVP and determine its objectives and investment strategy. Next, they may reach out to multiple investors with an offer to invest in the SVP. Once they have adequate capital in the pool, they invest it in the startup or project.

Any returns or losses the early-stage startup earns or loses are distributed among the participants. Of course, their share in the investment determines their proportionate share in the returns. This is why SVPs are also called “pass-through vehicles.”

Limited partner investors can become members of the SVP by adding capital to the fund. In return, they receive a membership interest, expressed in percentages. For instance, if the fund is worth $200K and a member invests $20K, their membership interest is 10%.

Any profits you earn and want to pay investors are shared among them according to the membership interest percentage. For instance, if the returns add up to $10M, each member receives $1M.

Once the SVP pool is set up, the GP wires the capital to your company in a single transaction. As a result, the SVP will appear as a single entry in your balance sheet. This strategy ensures that the cap table remains neat and organized without the clutter of multiple investors.

Essentially, the SVP is an investor in your company, not individual investors. However, the SEC has regulations that dictate the maximum number of investors in an SPV. If the SPV has raised $10M or less, it can have no more than 250 accredited investors.

However, say the special purpose vehicles for early-stage startup fundraising have more than $10M in AUM. In that case, they can have a maximum of 100 investors. Don’t forget that SPVs are subject to management fees.

Benefits of Special Purpose Vehicles for Early-Stage Startups

As the owner, you can leverage SPVs to gain funding and other advantages for your company. You can minimize risks and accelerate its growth.

• The most significant benefit is that you can consolidate your investors into a single entry in your cap table. Managing multiple investors can raise challenges with administration, especially when you raise further funding rounds.
• Attracting large investors in the initial stages of building your company can be tricky. Chances are that you need small amounts of capital that don’t align with large VCs, PE firms, and angels. In that case, an SPV could be the appropriate option.
• Since an SVP is an entirely independent entity and operates with its own balance sheet, it helps diversify risk.
• Reaching out to investors typically means submitting your company to extensive due diligence. If you’re not ready to divulge the company’s secrets and IP, opting for an SPV could be a better option. At best, the GP will be in charge of evaluating your company as a good investment.
• SPV fund managers are not likely to require voting rights or control over decision-making in the company. At the same time, the SPV gets legal protection from risk. This factor works well for both parties–the entrepreneur and investors.
• Raising funding from a special-purpose vehicle can give investors and the company tax rebates. But you will remain compliant with securities laws.
• Having raised funding from an SVP, your chances of further successful rounds are likely to go up.

Benefits of SPVs for Investors

Special-purpose vehicles work well for investors as well. Here’s how:

• Investors and limited partners (LP) looking for investment opportunities can take advantage of risk diversification. They can invest small sums of $1K and participate in the round. But, if they invested directly in the company, the minimum investment would be higher.
• LPs typically don’t have a say in how the capital is invested in a conventional venture fund. They must rely on the GP’s expertise and investment strategy. However, with SPVs, they know exactly how and where their money is invested. If they have any evaluation criteria, they can select the right SPV.
• Investors may come across an intriguing business idea that has the potential to disrupt the industry. However, if the concept does not align with their fund’s limited partnership agreement (LPA), an SPV is the next option. Organizing special-purpose vehicles for early-stage startup fundraising allows them to gather funding and back the startup. This fund is segregated from the main fund’s resources and operates autonomously.
• Investors can use the SPV instrument if they find a great concept but lack adequate money in the fund. Setting up a special-purpose vehicle allows them to collaborate with other investors and gather funds to back the company.
• SEC regulations and legal structures may limit how much money investors can invest in a startup, sector, geographical location, or funding stage. An SVP can be a great workaround for staying compliant with the law.
• Pooling money into an SPV is a great option for first-time investors testing the waters. They can invest small amounts of money in companies with potential, knowing that the money is secure. Gradually, they’ll build a portfolio of good companies and hone their skills.

 

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Benefits of SPVs for Angel Investors

Angel investors desiring to experiment with disruptive concepts they are unfamiliar with prefer to use special-purpose vehicles instead. This channel allows them to invest in verticals, asset classes, and investment categories with the help of the fund manager.

Angels with similar investment strategies can collaborate to create an angel syndicate. Although most angels are high-net-worth individuals, others are more interested in investing small capital amounts. Using SVPs also gives them access to later-stage companies.

The larger the SPV capital, the higher the investors’ negotiating power. By investing larger sums, investors can bargain for more favorable terms and conditions than individual investors. Angels also get a more prominent presence in the targeted company’s cap table.

Downsides of Special Purpose Vehicles

Although special purpose vehicles for early-stage startup fundraising have multiple advantages, you should know the potential downsides. Weighing the pros and cons can help you make informed decisions for your company’s long-term growth.

Organizing SPVs can be a complex process involving several legal ramifications. As an entrepreneur, you’ll have to ensure compliance with the relevant regulations. Factor in the paperwork and costs of hiring credentialed legal professionals to oversee the transactions.

From the long-term perspective, you’ll think about how the SPV will impact future funding rounds. Eventually, as the company scales, you’ll need larger amounts of capital from bigger VCs, PE firms, and other investors. Aligning the interests of these new investors with the SPV can be challenging.

From the investors’ perspective, they’ll invest money in a single company, which raises their risk significantly. Work out the costs and payable interest for getting backing before you sign the papers and agreement. Further, know that the SPV is an official shareholder in the company, not investors.

This factor means they don’t have any voting rights or say in the decision-making. They must rely entirely on the GP and their expertise.

In Conclusion

Like most funding options, special purpose vehicles (SPV) for startups have their pros and cons. Do the necessary research to understand exactly how they will work and the impact on your cap table. Make sure you understand how to structure them and stay compliant with regulations.

Weigh your options carefully before making the right choice for the company and its future success. An expert fundraising consultant can get you there.

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