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SPVs: The New Bridge Capital for VC Firms

Aug 2, 2022 4:01:57 PM | Assure Analytics

 

In an effort to shed more light on venture capital firms’ use of SPVs, Assure Analytics recently launched a data-driven series that leverages DifferentFunds’ industry-wide VC data to explore the role of SPVs in the U.S. venture  market. 

The first article sized the VC sidecar market, looking at time series trends in the prevalence of VC SPVs and total venture capital raised via SPVs. We found long-term growth in both SPV count and capital raised, with a particularly pronounced spike in the all-around outlier year of 2021.

But as 1H 2022 numbers begin to finalize (SPV fundraising data lags more than flagship fundraising since it doesn’t receive the same news and press release coverage), it appears VC sidecar vehicles are mirroring the broader slowdown in startup investing. 

Although we’ll continue to report on the state of VCs’ use of SPVs to raise capital and make investments, in this article we step back from broader trends and explore how SPVs fit into a typical venture capital strategy. Specifically, how do SPVs contribute to a VC firm’s total AUM, how much capital does a typical VC SPV raise, how are SPVs deployed into portfolio companies, and how does LP participation in SPVs compare to flagship fundraises?

The analysis in this article looks at 2,000+ U.S. venture capital firms, roughly 3,500 of their flagship funds, and 1,500+ SPVs.

Of course, for even more insights on this topic, download our 23-page report on How VCs Use SPVs

How SPVs Contribute to a VC’s AUM

We estimate that at least 20% of U.S. VCs who raised a flagship fund since the beginning of 2021 have also leveraged an SPV since the firm formed.

However, among VCs with at least one SPV, the norm is to have raised 3 to 6 SPVs to-date. This suggests that although it’s not necessarily common yet for venture capital firms to incorporate SPVs into their strategy, when they do, the investment vehicle becomes a rather significant contributor to their investment strategy.

Indeed, we found that for the median VC with SPVs in their portfolio, capital raised via SPVs totals about 11% of capital raised via flagship funds. And for the average, that percentage rises to 69%. In other words, for a VC with total flagship AUM of $100M, SPVs contribute an additional $10M to $70M of investable capital. Clearly SPVs can drastically increase the amount of capital a VC is able to deploy into their portfolio companies.

VCs SPV AUM

Typical Size

In recent years, the typical VC SPV has raised $1M, with the median holding steady since 2020. However, the average SPV size has varied between $7M and $10.5M, a sign of variation at the upper extreme – specifically, a decline in prevalence of exceptionally large SPVs since 2020.

One hypothesis for the higher average SPV size in 2020 is that VCs were more likely to turn to this structure that year for larger investments, rather than making those large investments out of a flagship fund. This may have resulted from the perceived increased difficulty in raising a blindpool flagship vehicle as investor appetite paused from the pandemic, meaning VCs adjusted to be more conservative with existing flagship AUM. If this was the case, we may see a similar upwards growth in the average VC SPV size for 2022, as the current downturn makes flagship fundraising more difficult.

VCs SPV Size

 

How SPVs Compare to Flagship Funds

While absolute SPV sizes are of course insightful, it’s also relevant to understand how each SPV a VC firm raises compares to what they typically raise through each flagship vehicle. The following analysis calculates each VC’s average flagship fund size and compares that to their average SPV size.

Among venture capital firms with SPVs, the median typically collects (through each SPV) 5% of what they collect through each of their flagship funds. The average VC, meanwhile, has each SPV collecting nearly 22% of their typical flagship fund.

An SPV raising just 5% of the capital a flagship collects may at first seem minimal; however, given VCs who leverage SPVs have typically raised 3-6 vehicles to-date, each SPV contributing 5% of a flagship vehicle can quickly approach a very significant contribution to a VC’s assets available for deployment. And keep in mind that flagship funds are typically distributed across 25 to 30 portfolio companies, while SPVs are often dedicating capital to one specific startup. 

It’s also interesting to note the wide discrepancy between the average and median for this figure. This suggests a few things: for one, SPVs aren’t limited to VCs with small flagship funds – in fact, among VCs leveraging SPVs, the average flagship fundraise is $104M, surpassing the perceived $100M threshold for established VCs and institutional capital. Second, for some VCs, SPVs are a very significant way to deploy capital and a single SPV can amount to a large addition to their latest flagship fundraise. Third, some follow-on deals may result in particularly large pro rata allocations – one where a VC can’t or does not want to fill that entire allocation via reserve capital from their core fund. In these cases, SPVs can help, which can further drag up averages. 

Deploying SPVs into Portfolio Companies

A few metrics offer insight into how SPVs are being used to fuel portfolio companies.

First, it appears VCs generally raise SPVs towards the end of a flagship fund cycle. Both the average and median SPV occur about 58% to 64% through a flagship cycle (meaning they’re closer to the next flagship fundraise than the previous one). This suggests the norm in venture capital is for SPVs to occur as a firm nears the end of the investment period for their last flagship fund, before refreshing their capital to begin backing a new cohort of portfolio companies. Assuming a 10 year fund lifetime, this data suggests SPVs generally occur around year 6.

There are a couple possible implications here:

 1) SPVs seem to frequently be used as pro rata investments in high-performing portfolio companies, since they’re occurring later in a flagship lifecycle, likely after most initial investments have been made and their stronger deals are raising subsequent financing rounds ; and 

2) Some VCs may be using SPVs as a “capital bridge” between flagship funds, possibly turning to single-asset SPVs when the planned reserves from the last flagship fund start to run dry.

VCs Cycle

The implied investment amount into portfolio companies through an SPV compared to a flagship check also suggests that SPVs are frequently used in follow-on, later stage rounds.

For this analysis, we’ve calculated each VC firm’s average initial investment out of their flagship funds and are comparing that to their average SPV investment size. To do this, we’ve conservatively assumed the typical VC reserves 40% of its flagship capital for follow-on investments. So to estimate average flagship initial investments, we averaged 60% of each VC’s total flagship AUM across their entire portfolio of startups. We’ve also assumed SPVs are single-asset.

Based on these calculations, the median VC injects 60% more capital into a given startup through an SPV than the firm normally invests through an initial flagship check. Said another way, SPV investments are 60% larger than a firm’s initial investment. And for the average VC, an SPV investment is over 11X larger than an initial check. 

This finding provides strong evidence that SPV investments are often for later-stage deals, as opposed to being used for new investments at a VC’s preferred entry round.

LP Participation in VC SPVs

Despite macro changes, the typical number of participating investors in a VC SPV (who are often the fund’s LPs) has held relatively steady over the last three years: the median raised from 10 to 13 LPs and the average from 16 to 20. The first half of 2022, however, has begun showing a decline in investor participation. It’s yet to be seen whether this represents shifting investor attitudes or a pull-back in the market. 

For context, these investor participation figures places normal LP check sizes at $75K to $100K for the median VC SPV and $500K to $1M for the average. Given the industry standard of $500K+ investment minimums for VC flagship funds, these figures imply VCs are frequently willing to lower their LP investment minimums for sidecar and pro rata vehicles.

VCs LPs

And how does LP participation in a firm’s SPVs compare to participation in the firm’s flagship funds?

Unsurprisingly, SPVs generally have fewer investors, each writing smaller checks. This makes sense, given SPVs are quite a bit smaller than flagship funds (meaning they require fewer investors to complete a raise) and typically only invest in one startup (meaning a highly concentrated bet as opposed to the more diversified offering of a flagship portfolio). However, the exact difference between investor participation in SPVs and flagship funds may be less drastic than expected.

The average VC with SPVs finds roughly half the number of investors / LPs in each SPV as in each flagship fund. The median, meanwhile, raises each SPV from about a quarter of the investors that participated in each flagship raise. This doesn’t necessarily mean 25% to 50% of the same LPs from a VC’s flagship fund are choosing to back that VC’s SPVs. However, assuming there’s quite a bit of overlap between a VC’s flagship LP network and their SPV LP network, this finding nonetheless implies a rather high rate of opt-in among a VC’s LPs for each SPV. (Read more about investor retention and network activation in SPVs broadly.)

Further, for the average VC, investor check sizes in each SPV are typically 90% of the size of checks in a flagship fund (note: check sizes are approximated as the average capital per investor in a vehicle). 

For the median firm this figure is a more significant 33% of flagship checks. However, that the average check size in an SPV is nearly on-par with that of a flagship investment provides some further evidence that VCs frequently use SPVs to back star-performers from the flagship portfolio. LPs being willing to invest the same amount of capital into a single startup deal that they invest in an entire portfolio suggests a high degree of confidence in the success of that startup.

VCs LP Participation

In short, our research suggests that when a VC firm chooses to leverage them, SPVs are a significant contributor to a VC’s strategy. VC SPVs tend to raise 5% to 25% of the capital raised by each flagship fund, frequently occur towards the end of a flagship lifecycle, and appear to most often be used to make pro rata or follow-on investments in high performing portfolio companies.

Next month, we’ll release an in-depth brief looking at other aspects of how VCs use SPVs, including comparisons across time, geography, deal types, and more. 

 

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