Thesis: Employee Led SPVs

Overview

External investors are currently the largest equity holders in startups at exit. Employees might be able to replace external investors as the largest equity holders.

An employee can buy shares in their employer with a one time use fund (Special Purpose Vehicle, or SPV). Employees will raise ~50% of the capital required for all Seed, Series A, Series B, and Series C rounds. The capital comes from the employees' personal networks.

Employees who lead SPVs are a new stakeholder in the startup ecosystem. As hybrid investors/employees, they earn carried interest and options gains.

Current state

At exit (acquisition, public listing, etc.), a company's cap table has a few categories of owners. There is often a massive ownership difference between each group.

  • Founders generally own 10%-30% of the company at exit. Founders buy common shares with a token amount of capital when they start the company.

  • Employees (former and current via the option/RSU pool) own or are allocated ~10%. Employees buy common shares by exercising incentive stock options. The company grants employees these options as part of the employee's compensation package. The options enable the employee to buy shares at a discount to market price. The company sets aside a certain amount of shares into an "options pool". This pool is usually between 10%-15% of the total shares outstanding. Current and future employees receive options from the pool. An option granted to one employee is an option that the company cannot grant to another. Employees who negotiate for more options are playing a zero sum game. Another way to think of the pool is as a ceiling

  • External investors (Venture Capitalists, Syndicate leaders, Corporate strategics, etc.) own the bulk of the company at exit. External investors buy ownership with capital. Investors can buy as many shares as the company is willing to sell. They do not have a ceiling in the same way that employees do.

  • Founders start the company and employees work at it. Investors provide capital and governance. How do they do that? Let's walk through a simplified workflow assuming

    • A single VC (Venture Capital) fund

    • A single decision maker (General Partner, or GP)

    • The fund purchases shares in a single company

    • The fund charges no management fee

    • All of the investors in the VC fund (Limited Partners, or LPs) are high net worth individuals.

  • A traditional VC fund is the same as the example but with a management fee, many investments, and often many GPs. The workflow is:

    1. The GP sources capital commitments (raises money) from LPs. The LPs agree to pay the GP a percentage of the profits (carried interest or "carry", usually 20%). The LPs pay the GP's carry in cash and/or shares of the fund's portfolio company after the GP returns LP capital.

    2. GP looks at various investment opportunities (dealflow) into fast-growing private companies (startups)

    3. The GP determines a valuation and desired terms for a target startup. The GP and CEO negotiate an agreement in the form of a term sheet.

    4. GP instructs the fund to buy securities from the company (leads the round)

    5. GP occupies a board seat where the GP supervises the work of the CEO

    6. GP exits the investment

      1. The company goes public or the GP sells the fund's shares to

        1. The company in a buyback

        2. A external buyer in a secondary sale

        3. An acquirer that is purchasing all the company's shares

    7. GP returns LP capital and collects carried interest from the profits.

Desired state

  • A potential startup employee is already doing many of these workflows

    • GP looks at various investment opportunities (dealflow) into fast-growing private companies (startups)

      • This is like interviewing with different companies before joining a startup

    • GP instructs the fund to buy securities from the company (leads the round)

      • Comparable to employee exercising Incentive Stock Option grants and then holding common shares.

    • GP exits the investment

      • The employee can exit via all the same mechanisms as the GP.

  • With modern tooling, an employee can also do more of the GP's workflows

    • The GP sources capital commitments (raises money) from limited partners (LPs). The LPs agree to pay the GP a percentage of the profits (carried interest or "carry", usually 20%). The LPs pay the GP's carry in cash and/or shares of the fund's portfolio company after the GP returns LP capital.

      • An employee can raise capital using Special Purpose Vehicles (SPVs). SPVs are single purpose and one time use funds. SPV formation and management was manual, expensive (+$60k), and time consuming. Technology enabled fund administrators now make this process cheap, quick, and easy. Investors pay their pro rata share of the SPV's costs.

      • An employee can source accredited investors using social media and productivity tools. GPs use many of these same tools.

    • The GP determines a valuation and desired terms for a target startup. The GP and CEO negotiate an agreement in the form of a term sheet.

      • An employee can replicate this by asking for allocation into either

        • a priced round where an external investor has already set the terms.

        • an ad hoc bridge round through a SAFE. An external investor will determine the share price and terms at the next priced round.

    • GP returns LP capital and collects carried interest from the profits.

      • The SPV administrator handles this.

  • This means an employee can

    1. Determine which startup to join

    2. Secure allocation

    3. Raise capital via SPVs

    4. Repeat 2 and 3 as often as possible

    5. Collect carried interest from the SPVs after exit.

How to change states

  1. Build and validate a process for employees to get allocations and raise >$100k in LP commitments from their personal networks

    1. The Employee's Guide to Employee Led SPVs

  2. Build a process that outputs at least 5 startup employee SPV leaders every week

    1. How to Source Employees for Employee Led SPVs

  3. Build syndicate of >1,000 LPs to invest capital into employee led SPVs. The syndicate should generate >$500k in commitments within 24 hours of a given deal going live. This capital is on top of what the employee sourced.

    1. Someday/Maybe

  4. Create a committed capital fund to invest in employee-led SPVs. The fund would match what employees raise. The fund would increase the match ratio as the fund's capital base grows. The fund makes sense if it is feasible to deploy >$10m/year

    1. Someday/Maybe

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