What led me to originally investigate the idea of formalizing and scaling employee led SPVs?
|Sep 19, 2020||3|
In June 2019, I co-led an SPV (special purpose vehicle) to invest into a growth stage startup. I found fundraising from accredited investors to be very similar to B2B (Business to Business) go-to-market and sales. Using the same tooling and processes, we generated far more investment interest than the allocation we could invest in the company. I asked myself "how can I build a machine that would get me and my teammates any sized allocation into any company at any stage?"
Around the same time
I helped a few startup employee friends negotiate for more options. Despite their impressive output, they kept hitting a wall when trying to get more options after reaching their cliffs.
I sold some common shares in a tender.
I then thought "what if I co-led an SPV into one of my previous employers when I joined and then sold the SPV's shares during the current tender?" The hypothetical capital gains in the form of carried interest were enormous (>~8 figures).
They also scaled with how much I could raise. The amount I could raise was not fundamentally capped in the same way that options grants are limited by the size of the company's option pool. While the options pool is generally ~10% of the fully diluted shares outstanding at any given time, theoretically the rest of the cap table (excluding what is owned by founders) is up for grabs.
I remembered meeting a few people who had done something similar and started researching why employees raising capital from their networks using SPVs and investing in their employers was not more common.
I spoke with founders, investors, lawyers, employees, etc. across all stages. I found that the main reason was that no one had built a scalable and repeatable process for doing so. I decided to build this process in public and open source all my findings.
Many people thought there were legal, regulatory, etc. issues. I spoke with multiple fund and securities lawyers to find that there were no material roadblocks.
I analyzed exits and concluded that it made most sense to co-lead SPVs into primary priced and bridge rounds at Series A-C stage companies.
Anything later and the exit multiples were not that interesting.
Anything earlier and the risk goes up dramatically along with the fundraising difficulty
I spoke with more employees and CEOs and realized that there is a major benefit to employees getting more equity upside without using the options pool: retention. More incentive alignment is good in theory but retention is the hair on fire problem. Startup employees often leave after 18-24 months. The company loses the employee at their point of peak domain knowledge, mutual trust, effectiveness, etc. Retaining a top tier employee for even an extra 6 months could have a disproportionate impact on the company's growth.
I also researched helping employees lead SPVs to buy secondary shares in their companies. This didn't seem to be worth the extra hassle of sourcing the shares, negotiating approval for the trades, and also the increased regulatory burden if I and the employees wanted to earn carry from investing in secondaries. Investing in primary rounds generally falls under the venture capital advisor exemption. Investing in and earning carry from secondary SPVs seemed to fall under a different and stricter regulatory regime.
It quickly became clear that if I or an affiliated entity provided all of the capital for the SPVs, then I'd run into moral hazard: every single startup employee would be incentivized to lead an SPV regardless of quality of the company. The carry is effectively a free call option on the company's shares.
So I realized the move is to have employees raise some capital from their network initially as a sort of proof of stake. And then once that benchmark was hit, I could then circulate the remaining allocation in the opportunity to a syndicate and eventually could take a portion or all of the remaining allocation for a fund.
If enough employees decide to execute these SPVs, the world could dramatically change.