The CEO's guide to Employee Led SPVs

Target Audience

Overview

An employee can form a special purpose vehicle (SPV) to fundraise from their network . The employee led SPV can be a minority investor in the employee’s VC backed employer's funding rounds.

The employee can earn carry from the SPV in the case of a positive exit. This carry can in some cases be worth a life changing amount of money. This is on top of  whatever the employee will earn from their ISO/RSU grants.

An employee is making an investment decision when asking the CEO for allocation. The CEO should not think of providing allocation to an employee as a form of compensation. Allocation is not a replacement for salary and/or equity grants.

Why accept capital from an employee led SPV?

  • Benefits

    • Employer

      • Increases principal-agent alignment of top tier employees without draining the option pool. 

      • Reduce voluntary turnover in the most enthusiastic and capable operators. 

      • Far less friction, cost, risk, and potentially dilution than taking on venture debt. 

      • Receive capital on market terms from a known and passive entity. An employee is already on the cap table as an options holder.

      • Liquidity for existing common and preferred shareholders in the case of an employee led SPV purchasing secondaries

    • Employee

      • The carry acts as more equity upside to the employee which they can scale by raising more capital. The carry is asymmetric positive leverage like the carry earned by a VC firm. See this financial model to explore scenarios.

      • This is an enormous incentive to stay at a company and improve its performance. The carry from raising many SPVs across a company’s lifecycle can be almost as lucrative as being a founder. 

  • Risks

    •  Employer

      • Employee may leave after X months and still be on cap table in a larger way than they would be if they had not raised an SPV

        • Employees have extreme financial and social incentive to stay at the company. Investors want the employee working to improve the value of their investment. Investors will assume that the employee will be at the company full time for as long as possible.

    • Employee

      • The employee may suffer reputational harm if the company does not have a positive exit

        • Employees should clarify that the investment is high risk and has no liquidity. Investors should value their investment at $0 after wiring funds.

How It Works

This will look like any other LLC/LP investment entity that is already a minority investor on the cap table. An employee forms one SPV per round. The round can either be a priced round or a bridge round. An SPV can purchase primary preferred shares or a SAFE from the company.  An SPV can also purchase secondary common or preferred shares from existing holders. 

The most common primary investment type outside of priced primary rounds is an uncapped SAFE with a 20% discount. The absence of a cap gives the CEO more freedom to set the price in an upcoming priced round without investors using the cap on bridge round SAFEs as anchoring points.

The CEO generally does not need additional board approval for the employee SPV’s allocation if the employee is investing in a pre-approved priced or bridge round. 

The CEO may need board approval to allow the employee to invest via

  • An ad hoc SAFE in between rounds.

  • Purchasing secondary shares 

Increasing Effective Tenure

This average overstates effective tenure. Assume

  • 3 months to recruit a top tier candidate

  • 3 months to onboard them to full productivity/enthusiasm 

  • 3 months of reduced productivity/enthusiasm at the end of their tenure prior to their last day (inclusive of their last 2 weeks)

Even a ~2 year tenure then begins to look closer to a 1.5 year tenure at peak enthusiasm/productivity. The employee leaves  at the peak of their domain expertise and company/org level context. The company and employee interrupt compounding at the point of largest future gains. Every additional employed day amortises the cost of their recruitment.

FAQ

  • Does an employee asking for allocation for an employee led SPV mean that the employee is unhappy with their role or current level of equity?

    • Not necessarily. Often an employee asks for allocation for an SPV because the employee is extremely enthusiastic about the company, the employee’s role, and the company’s potential.

  • How much allocation should the CEO offer to an employee?

    • The CEO should let the employee know that they are open to an employee led SPV and ask the employee to come back with a commitment amount after the employee has gathered soft commits. A soft commit is defined as a documented informal  agreement (in the form of email confirmation) to invest X dollars from a named individual or organization.

  • Is allowing an employee to take part in a round a form of stock based compensation like ISOs/NSOs/RSUs?

    • No, the investment thread is separate from the employment/compensation thread. The employee acts as any outside investor.

  • Do employee led SPVs increase dilution?

    • No. Employee led SPVs invest in rounds that the company will raise regardless.

  • Does allowing employee led SPVs affect the company’s 409a price?

    • They should not affect the 409a price but double check with your 409a analyst.

  • Do employee led syndicates complicate any future rounds?

    • Employee led SPVS are like any other other minority investors. The SPV executes a drag along clause which streamlines voting logistics.

  • Does the CEO need to interact or be aware of any of the SPV’s investors?

    • No, the SPV will generally execute a drag along clause and act as a single line item owner on the cap table.  

  • How will angels and VCs see the presence of employee led syndicates?

    • Public market investors see insider buying as a major positive signal. VCs and angels are likely to see employee-led SPVs the same way.

  • What should the CEO say in response to if an employee wants to invest as a condition of joining the company?

    • CEOs should respond that they are open to the idea of employees investing. They should discuss allocation after the employee has been with the company for 90 days.

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