BFP #OpenLP Series (5) — How much to charge for an SPV
Why use SPVs?
Many VC managers use single-asset, special purpose vehicles (SPVs) to give their LPs access to direct investment opportunities in their portfolio companies. SPVs increase the manager’s fee-generating assets-under-management as they pass on unused pro-rata rights in follow-on funding rounds of their portfolio companies.
LPs invest via SPVs in order to 1) get additional exposure to highly sought-after direct deals that they might not otherwise have access to, and to 2) lower the blended average cost of their exposure to Venture Capital. Fund of Funds, Corporate investors and Family Offices are the LP groups most likely to be interested in direct co-investment opportunities.
How do SPVs work? How much do they charge?
In the USA, most SPVs are structured as low-cost Delaware LLCs. European firms tend to use local, tax-transparent structures (although some of them are not as efficient). Some SPVs manage only a few hundred thousand in capital, whilst others manage many millions of dollars.
Management fees typically range within 0% and 2%, whereby formation costs and third-party expenses (“organizational expenses”) are borne by the SPV. Carried interest typically ranges between 10% and 20%, depending on the demand for the opportunity. Some GPs offer low or no fees (= direct access) to advance the relationship with their LPs.
BFP’s take on fees
At Blue Future Partners, we believe that it does not make sense for investors in SPVs to have a 2/20 fee structure for single asset SPVs. This assumes that the risk of default or a write-down on the underlying companies is still reasonably high.
This reasoning is underpinned by the following, simplified mathematical calculations:
The next best alternative for LPs is to invest in a fund, where the losses and write-downs get offset against any capital gains before carried interest is applied.
Using the same assumptions as above when calculating the effective carry paid for a portfolio of single-asset SPVs yields the result below:
Therefore, an LP holding a portfolio of single-asset SPVs does not enjoy the benefit of losses being offset against the gains in other SPVs. This leads to the LP paying an effective carry of >25% on her portfolio of SPVs. It therefore makes more sense for the LP to invest in a Fund with 20% carry rather than a portfolio of SPVs.
Lowering the assumed carry on the portfolio of SPVs to 15%, based on the same gross return assumptions as above, the LP pays a blended average carry of just below 20% as illustrated in the calculations below:
In this scenario the LP pays roughly the same carried interest as if she had invested in a Fund instead. Given the presumed objective of some LPs to use direct investments to lower their average costs of fees, the carry on SPVs needs to be significantly south of 15%.
Of course, there is also a trade off in relation to management fees, whereby for obvious reasons most LPs would trade a lower management fee for a higher carry.
We are highly appreciative of any GPs willing to share direct investment opportunities and recommend a 1/10 fee structure for single-asset SPVs. This gives GPs the opportunity to leverage their platform and LPs the chance to lower their average cost of fees, thus representing a win-win on both sides.
Exceptions apply for exceptional opportunities!