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A New Vehicle that is Changing the Way Startups Raise Capital

  |  By Christopher Orr, SDIP

A recent article in the Wall Street Journal explains how startup investors are using an emerging funding structure -- special purpose vehicles or SPVs -- to raise big sums of money from venture capital investors. But SPVs aren't only being used by highflying tech companies that are looking to raise hundreds of millions of dollars. In the following Q&A Alejandro Cremades, co-founder of online startup investing marketplace Onevest, explains how SPVs are being used by early-stage companies that need to raise money.

CO: What is a special purpose vehicle (SPV)?

AC: An SPV is a legal entity that can own debt or assets such as equity, trademarks, brands, copyrights or patents. This flexibility offers two ways to raise capital. The first way is through debt financing. A company seeking a loan can put assets in an SPV as security for a loan from investors. A patent, for example, would offer investors a potential income stream that could be used to pay the loan back over time. If structured properly, the SPV would continue to hold the patent and pay investors, even if the startup went out of business.

"All of the investors in the SPV are pooled into a single entity, and management deals with one point of contact, the SPV organizer, who represents all of the SPV’s investors."

The second way is equity financing. All of the investors in the SPV are pooled into a single entity, and management deals with one point of contact, the SPV organizer, who represents all of the SPV’s investors. A startup can meet its funding minimum by gathering smaller sums from more individuals while requiring less time communicating with them.

At the same time, the SPV organizer can be the main point of contact with investors for communications about the company and questions about their investment. This can be particularly important for individual investors, who may have used private savings, such as an individual retirement account (IRA). As a result, they may be more risk averse than a traditional angel investor who has experience in startup funding and its risks.

CO: How have SPVs typically been used?

AC: SPVs are typically used by established companies that want to raise additional money. They were a niche financing vehicle and the investment minimums were generally high. For example, $250,000 was a common minimum.

CO: How is the use of SPVs evolving?

AC: SPVs have been used to purchase equity from early investors in companies like Pinterest and Twitter, and startups are beginning to turn to SPVs as a way to attract more investors at lower minimums than have generally been the norm in private equity.

CO: How can SPVs be used in equity crowdfunding?

AC: The typical minimum investment for an angel investor can be $25,000 or more, but at Onevest we see many deals with $10,000 minimums and some as low as $5,000. This creates opportunities for a much larger pool of investors than ever before. It opens the possibility that individual investors can access high-quality early-stage deals without needing "to know someone." For company founders it means an even better chance that their business will win backers based on merit.

"But to fully unlock the opportunity in equity investing, early-stage companies need to find ways to manage a larger, more diverse investor base. This is where SPVs can be a perfect fit for equity crowdfunding."

However the prospect of more, smaller investors can be daunting because it can be difficult and time consuming for a startup to communicate with so many participants. But to fully unlock the opportunity in equity investing, early-stage companies need to find ways to manage a larger, more diverse investor base. This is where SPVs can be a perfect fit for equity crowdfunding. As I mentioned above, all investors in the SPV are pooled into a single entity, making life easier for a startup, and a startup can meet its funding minimum by gathering smaller sums from more individuals. This leaves more time and space for the early-stage company to focus on the business.

CO: What are the risks that investors need to know about?

AC: For early stage companies, there is high probability that investors could lose their entire investment. All investors should understand the level of risk before investing

and consult with a lawyer or financial advisor before becoming involved with an SPV.

From our experience at Onevest, when performing due diligence on these opportunities investors should pay close attention to the following factors:

  • A seasoned founding team with a track record of success and knowledge in the industry;
  • A product or service that solves a real problem in a unique manner and sets the company apart from the competition;
  • Momentum in the investment offering, evidenced by other investors, and clear terms
  • for the offering;
  • Validation for the company, sometimes known as “traction,” in the form of revenue, key partnerships, signed agreements indicating future revenue, or other concrete indications of its future prospects; and
  • A tenacious founder who will finish the marathon to the exit strategy.

To learn more about equity crowdfunding, click here to download a copy of the 2015 PENSCO Crowdfunding Report.