Three key sets of activities that must be performed in the aftermath of an SPV investment: Pro-Rata Rights, Membership Transfers, and a range of required Corporate Actions.
14.1 POST CLOSE: PARTICIPATE OR IGNORE PRO RATA ALLOCATIONS WHEN FUTURE FINANCING ROUNDS OCCUR is trifurcated into the following categories: LEGAL, COMPLIANCE and ADMINISTRATION.
Pro rata rights are exclusive to startup companies, and the most common reason people launch SPVs. When a startup company grows and raises follow-on funds, some of the early investors may have the right to invest more capital in the company. These rights are called pro-rata rights. In venture capital, a pro-rata clause is an investment agreement that gives the investor the right (but not the obligation) to participate in one or more future financing rounds in the interest of maintaining their percentage stake in the company. Pro-rata opportunities are typically addressed in one of three ways:
- Released or ignored – additional capital is not invested
- Existing investors in the SPV contribute additional funds and the cap table of the SPV will change
- A new capital-raising SPV is set up to pool capital and invest
Participating in a future financing round incorporates many of the 17 tasks of a capital-raising SPV – including documentation, setting up a bank account, onboarding investors, completing the purchase agreement, security filings and cap table creation. In addition, participation will impact taxes and distributions.
14.2 POST CLOSE: DEAL WITH MEMBERSHIP TRANSFERS is shared among the following categories: LEGAL, COMPLIANCE and ADMINISTRATION.
It can be several years between the time an entity onboards investors and an exit occurs, especially when investing into startup companies. Investors’ lives move forward, and sometimes they need to transfer their investment from one entity to another. This is called a membership transfer. Membership transfers require legal documentation and cap table updates. They are considered taxable events so a tax return and K1s will be generated. In this case, we are not referring to selling membership interests but simply to transferring them. Examples may include:
- Investing as an individual and then setting up an LLC to aggregate all of your investing activity, so you transfer this SPV investment into your new LLC entity
- Divorce: You may need to split the asset into two–-in other words, transfer part to a former spouse
- Trust: Setting up a trust in order to pool all assets into that trust
- Death: If an investor passes away, the asset needs to be transferred to heirs
14.3 POST CLOSE: MANAGE ALL OF THE CORPORATE ACTIONS THAT REQUIRE YOUR ATTENTION lands in the following categories: LEGAL, COMPLIANCE, ADMINISTRATION and possibly ACCOUNTING.
Corporate actions occur when the asset into which the SPV has invested requires–or when its principals decide–that its investors will vote on one or more matters. Using our example of investing in a startup company, there is a long list of matters that may arise that will be presented to the SPV, as a single aggregate investor, that will need to be signed off. These matters vary in their level of importance. The request generally comes in the form of legal documents, and the results of the action may impact the value of the investment, either positively or negatively. Here are some examples of potential corporation actions when investing in a startup company.
- Shareholder resolutions
- Shareholder meetings
- Changes to the board
- Company restructuring
- Asset sale
- Stock splits
- Round extensions
Exits are classified as corporate actions–and the ultimate reason for making the investment in the first place. An exit is the very broad term for all outcomes, both positive and negative, for a private asset investment. Bankruptcy, ABC (activity-based costing), shut-down, acquisition and IPO are the most common exits.
Now that we have effectively managed all essential post-close activities, we are ready to move on to STEP 15: MAINTAIN THE ENTITY EACH YEAR.