“Sorry, that ticket size is too small for us.”
I’ll never forget the last time a founder told me that. Call it Ego, if you want. I certainly do! But I promised myself that I would never miss out on a deal due to my ticket size being too small again.
Easier said than done when you are a small-ish angel investor. After all, the money you have in your bank account is all you have to play with(never borrow money to angel invest!).
However, there is an established practice of syndicating deals. That is, multiple angels join forces to invest from a single legal entity and thus reach a larger collective ticket size. This concept is generally referred to as an SPV.
SPV is short for Special Purpose Vehicle, which simply means a legal entity that exists for one purpose only. In the context of angel investing, this purpose is to serve as the legal entity from which the actual investment is made.
In this post, I will try to deconstruct the SPV concept and other options for syndicated investments, and try to give some insight into how it works and why I think it can be a good alternative to direct investments.
One disclaimer before we dive in: At the end of the day, I'm just a dude on the internet. I am not a financial advisor, and you should never invest money that you cannot afford to lose. You should also do your own research before doing your first angel investment, including SPVs.
Alright, let's go! 🚀
While I have my preferred way of doing SPVs, there are multiple ways to actually co-invest. These are the three ways that I’ve seen working fairly well and potential risks with each model.
Co-investment through one person's existing holding company.
This works best if you are a small number of investors (1-3), who already know and trust each other. I’ve seen this work out when one person has a holding company set up and already has some allocation in a round.
For example when the owner of the holding co is already an investor in a company but doesn’t have enough liquidity to fill up their pro-rata1. Their friend on the other hand has the money, but no pro-rata.
This option is the one I like the least, and should only be considered if every other option is unavailable for some reason. Putting money in something that already exists comes with a risk of mixing cash flow streams, which increases the complexity. And there is always a risk that there is some liability that could endanger the other investors' money.
Use with caution.
Form a new legal entity for each investment
This option works very well for me personally. I already have a good understanding of the legal frameworks involved, I almost exclusively invest in Swedish startups, and the number of investors I include in my SPVs is relatively small (less than 10).
The reason why the number of investors is important is that there is a lot of manual admin involved to make sure everyone in the SPV gets the same (and correct!) information, has signed the proper paperwork, and sends in the money on time.
There is some legal overhead associated with setting up a company, in the form of a Shareholders Agreement (SHA), but after doing it the first time you’ll have a basic template that you can reuse.
Forming a new entity for each new investment is a clean and flexible option, as it allows everyone to participate on a case-by-case basis in a straightforward manner.
If you are a group that plans to make multiple investments together, you might opt to do them from the same entity every time. Essentially, it forms a micro fund. This reduces administrative overhead and costs. However, if just one out of the people involved opts out, you immediately get more complexity than it’s worth.
If you are doing everything manually, I highly recommend sticking to one legal entity per group and deal as this will be simpler in the long run.
Using a platform
As the number of co-investors grows, the need to automate administrative and legal work grows with it. Luckily, there are some great options out there that do all the heavy lifting for you, and simplify everything from KYC2 and finding investors for your SPV to structuring carry3 and potential management fees4.
They do come with fees of their own though. So while I’m confident I will move to one of these platforms as I expand my investing, it just doesn’t make sense for me at this stage.
Some of the more popular platforms I’ve come across are:
Which platform is best depends largely on where in the world you are, where the startups you invest in are, and what your needs are beyond the simple SPV. Do you want to be able to find new investors? Do you eventually want to raise a fund? Do you want the option of selling secondaries5? These are all questions that you need to answer for yourself before choosing a platform.
A fourth option
As I touched on in my previous blog post on angel investing, there is also the option of co-investments using crowdfunding platforms such as Republic or Wefunder, or community investing like Vitalize Angels. As I consider crowdfunding different from SPVs (though technically very similar), I will leave that discussion for a later blog post.
As I touched on briefly in the introduction, the ability to invest at a larger ticket size was the main reason I started looking into ways to co-invest. But why does the founder care if you invest as one or 100 entities? Isn’t more money good money?
Yes and no. First, there is added overhead to every new investor the founder adds to the captable [footnote with definition]. This overhead consists of reaching out to more people to get everyone to sign on for new investments, more people to chase to make sure all the money gets transferred to the company, and more people that need to be notified during monthly updates and that need to vote on issues during shareholder meetings.
If it sounds familiar, it is because it is the same overhead that you will take on if you decide to lead an SPV.
A single line (vs 100) is also attractive to VCs. Anything that signals structure and less headache increases the odds of getting a VC to invest. It probably won’t be the thing that makes them say yes, but it might be the thing that gives them an excuse to say no.
After a Series B, it’s not uncommon to roll up smaller investors in a separate entity or have them sign a new SHA, where they waive their voting rights on certain issues. But in the early stages, this is too expensive, both in time and money.
For me, there is one motivation that made it all click for me. As the lead of an SPV, I can charge a carry on all deals. Carry, or carried interest, is a type of success fee that gets paid out after an exit, but before any profits are returned to the other investors in the SPV. This success fee is usually set to around 20%.
Carry is calculated on the profits, so if the investment does not do better than break even, no carry is paid out. You can also have a hurdle rate, i.e. a target return amount that must be met before the lead can claim any carry. It’s not uncommon to have a tiered carry, so if the investments produce returns above a certain threshold, the carry gets set to a higher number.
The advantage of charging a carry can be summed up in a single word:
It enables you to produce great returns with relatively small initial investments, without increasing your risk. And as any good early-stage investor knows, this is a game of increasing one's returns.
Risks and downsides
Early-stage startups are one of the riskiest asset classes you can invest in. And while syndication can be a tool to reduce risk for the investment itself, it's not all sunshine and rainbows.
Investing through platforms
It’s no secret that the platforms I mention exist to make money, so naturally, there is a fee tied to the SPV. These fees are usually based on a percentage of the funds raised. With platforms like Odin though, they are capped at a reasonable level. You just need to make sure to raise enough money on the SPV for the fees to make sense. It’s also not uncommon for everyone in an SPV to split the fees pro-rata1.
There is also a platform risk with investing through these actors. SPV platform Assure made the headlines in November 2022 when they abruptly shut down and gave their customers a little over a month to move their SPVs off the platform. The money that these customers paid in advance to have Assure manage their SPVs was gone.
This is not to say that you should never go with a platform solution. As I've already mentioned, as I grow my base of co-investors I will definitely start using a platform to manage my deals. Just be aware that there is risk associated with it.
Joining an SPV
The fact that it enables you to invest in smaller ticket sizes also means this is an excellent first step if you are just getting into angel investing since smaller ticket sizes mean you can take more bets and be exposed to more deals and founders6, and through that get more opportunities to learn how more experienced angels play game.
As an added step, make sure you also do some due diligence on the person who is leading the SPV, so that the person doesn't just take your money and run. I’ve never heard of this happening on AngelList and similar platforms, but I do know of people losing their money when investing in a manual SPV led by a person they didn’t know beforehand.
Lastly, when joining an SPV you may or may not receive information rights. In other words, when joining an SPV you shouldn't expect to be told what is going on inside the company you've invested in.
Leading an SPV
As it usually goes, more people means more headaches. At least if you are the one who is leading the SPV. Part of the deal is usually that you get all the questions that the founder would normally get. You are also the one who suddenly needs to chase down people who committed money and signatures of the same.
At its core, you have a supply and demand problem on your hands. On one hand, you need to negotiate allocation with the founder(s), and supply of shares. On the other, you need to find enough investors willing to buy the shares you have in your allocation. Or, in some cases, restrict how many shares each investor gets to purchase.
If it’s a hot deal7, you need to perform this matching quickly or risk burning your chance to invest.
A similar problem appears when it’s time for the company to raise its next round (and there is always a next round). Everyone who invested in the first round might not have enough capital to participate and take their pro rata 1. And if one person in your SPV drops out, then the odds for more dropouts increase. How you will handle these situations is something that you will have to think about beforehand.
You should now have a fairly good idea of how to invest with others, and where potential pitfalls might be. However, there is one last thing that I haven’t touched on. That is why, if I’m already going through all this trouble of setting up a new legal entity and finding people to invest alongside me, do I not go all the way and raise a proper fund?
Truth be told, in the future I just might. For now, though, I like the lightness and flexibility that the SPV provides me. SPVs can be done on a case-by-case basis, but with a fund, I would have pressure from my LPs8 to deploy the capital during a certain time frame. And while I do a lot of work with angel investments today, it’s far from a full-time job. I like to keep it like that.
For fledgling angels, I do think investing through syndicates is a good way to get started. You get the opportunity to invest smaller tickets alongside experienced investors and hopefully take part in their due diligence. Depending on the feedback I get on this post I might write more about this in the future.
Until next time!
Pro-rata simply means "according to your stake in the company you've invested in". So if you own 1% of a startup pro-rata rights give you the right to buy 1% of the shares offered in the next round of investments. ↩ ↩2 ↩3
Know Your Customer ↩
The origin of the term carried interest, or carry for short, can be traced back to the 16th century where captains would get 20% of the profit of the goods they carried back from Asia or the Americas. ↩
Funds usually charge a management fee of 2% to pay for the operating costs. SPVs usually don't have any such costs, but it's not uncommon to see management fees for SPVs led by more professional angels. ↩
Secondaries is short for secondary transactions, and simply means selling your shares in a private company before an actual exit occurs. ↩
A "hot deal" simply refers to a deal that a lot of angels and VCs want to get into. Usually means a higher valuation for the same quality of deal. ↩
Limited Partner. Investors in funds. ↩
After over a decade of building apps, teams and companies, I've now started coaching founders and CTOs through something that I call Nyblom-as-a-Service.
If this is something that would be interesting to you feel free to schedule a free discovery call to see if we are a good match for each other.