Your VC fund is a success when your LPs are happy. This is putting it very bluntly of course, and disregards many factors, but ultimately it can be brought down to that very simple sentence. With that in mind, what if there’s a way to not just offer great returns, but really supercharge them?
Let me explain.
One of your portfolio companies is performing exceptionally well, and you secured a follow-on allocation in their Series C. However:
1. You can't follow from your early-stage focused fund;
2. Concentration limits prevent you from putting any more money; or
3. It does not really fit within your investment thesis
You know it would create great returns for your LPs but from the fund’s perspective it’s just not economically feasible. Whichever the case, you pass on the follow-on allocation.
Sounds familiar? That’s because these are common issues VC funds run into, among a variety of other reasons that ultimately leave you struggling to take advantage of valuable rounds and deals. Your LPs are missing out on higher returns.
There is a solution however, in the form of a co-investment special purpose vehicle (SPV).
An SPV is a single-deal syndicate created ad-hoc that can be used to invest on a deal-by-deal basis. Specifically, those deals a VC would have otherwise had to pass on, the ones not fitting its core strategy, or just further rounds that give your LPs additional exposure to that one highly attractive portfolio company.
An SPV can take various legal forms, but is always a tax-transparent entity with only a few maintenance requirements.
You can invite your LPs to invest in the SPV, which in time will supercharge their returns, and the VC can take carry and a management fee.
SPVs are cost-efficient, making them a viable vehicle even for those smaller allocations, and easy to set up; incorporation is a matter of days, and the SPV can be fully up and running, bank account included, in a week. Perfect for those last-minute deals!
Let’s look at an example of how an SPV can supercharge your LPs returns, by creating additional exposure below.
The VC Fund column shows you what you would earn by only investing through your VC Fund, whereas (as below) adding the column: "ABC" SPV means also investing by way of a deal-specific SPV. The returns could jump from $47.5M (238%) to £63.5M (303%).
The above table clearly shows the benefit of co-investing. LPs are increasingly catching on to this, realising the great potential, which creates a “SPV”-trend.
Don’t be surprised if your more savvy LPs will proactively start asking you to do co-investment. Having such rights explicitly embedded in your VC fund means a competitive edge.
Your LPs will be happy with the increased returns you created for them, but there are some things to look out for. For example, cherry-picking your favourite LPs to invest in an SPV may create friction with the other LPs (although offering pro-rata rights can solve that).
Also, watch out not to get “carry”-ed away. A strategy in which the core fund is just used to identify the winning portfolio companies, with follow-on SPVs investing only in the “winners” (to inflate the carry), would surely not be appreciated by your LPs in the long run. Therefore, SPV responsibly and keep your LPs happy!
Vauban SPVs can be domiciled in the UK, the US, or the British Virgin Islands.