SPVs and SAFEs

by Ross Andrews

The SAFE (Simple Agreement For Future Equity) has become a standard agreement used between early-stage founders and investors. The terms of a SAFE have largely become standardized with minor tweaks or terms being added at the discretion of both the investor and the target investment company. SPVs much in the same way have largely evolved a standardized structure to facilitate a group of investors pooling capital and investing via a SAFE as a single line on a companies cap table. Today we take a look at how together, they create a standardized and streamlined way for investors and founders to come together to fund early-stage startups.

First, let’s take a look at the SAFE and some of the more important terms. A Simple Agreement For Future Equity is a purchase agreement to invest capital in a business that converts to equity in a future financing round. In return for the delay in actually receiving equity in the business, the investors typically receive a cap on the valuation at which their equity converts and/or a discount to the price of the next round.

The valuation cap would typically be something like “The Post-Money Valuation Cap is $4M”. So if you are a group of investors that invested $250k in the business and 12 months later the founder raises a $1M seed round at a $7M valuation. Your $250k would then convert to equity worth $500k at the time of the seed rounds closing.

The discount is another mechanism in which founders and investors can negotiate a SAFE. A discount typically is represented as a percentage off of the valuation in the next round of capital raised. Take the example above from the valuation cap. Instead of a $4M valuation cap, you could instead negotiate a 25% discount to the next round. In this case, the SAFE investors would get to convert their investment into equity at a 25% discount to the $8M post-money valuation of the business which is $6M.

Other than that plus any special terms that parties may decide to add, the terms of a SAFE are pretty widely accepted in venture investing circles, and therefore it allows investors and early-stage founders to move quickly.

Much in the same way a SAFE has streamlined early-stage deal terms, SPVs have helped streamline the ability for groups of individual investors to come together and invest in startups and other private assets in a single, simplified line on the cap table. We will cover the standard SPV set up as well as the terms that are typically negotiated between and SPV Manager and any investors.

First, an SPV is structured as an LLC (typically a Delaware LLC) with pass-through taxation or is often referred to as a disregarded entity. This simply means that the income of the LLC itself is not taxed and any income or capital gains taxes that the SPV LLC generates is passed along to the owners of the LLC. This brings us to the first important part of an SPV, the Operating Agreement.

The operating agreement is a largely standardized document outlining the reason for the LLC to exist and operate. In the case of private deals, this is focused on the purchase of a specific private asset such as equity (or a SAFE) in a private company.  The operating agreement also highlights that the manager of the LLC is the sole decision-maker on behalf of the entity and that any investors are members of the LLC in that they get an ownership stake in return for the capital they contribute to the LLC but similar to a Limited Partner in a fund, have no active day-to-day role in the business.

The operating agreement will also include terms around information rights which give the LLCs members (investors) rights to get information about the LLC and their investment from the SPV Manager when they request it.

In addition to the Operating Agreement, SPV LLCs often come with a Private Placement Memorandum or PPM. A PPM is a standard document in private investing which each member of the LLC must sign which outlines the risks associated with investing in a private asset such as a startup or a piece of real estate. It also highlights the illiquid nature of your private investment and that you may not be able to sell your investment for some time. The PPM also states that the investor who is signing the document has reviewed all of the deal information and terms and is comfortable with what the SPV will be investing in or purchasing.

The last core document to an SPV is its Subscription Agreement. The Subscription Agreement is where the SPVs members commit to how much capital they would like to put into the SPV. Each investor's contribution helps factor into what % of the SPV LLC that each investor (member) owns.

The OA, PPM, and SA represent the three pillars of any SPV with a few variables that are adjusted on an SPV-to-SPV basis. One being carried interest charged by the SPV Manager, this is easily written into the Operating Agreement and it is declared as a percentage of any carried interest that the SPV manager will charge investors on any gains on top of the principal invested. Second, are the fees associated with forming and maintaining an SPV. The manager can either take those fees out of the funds raised resulting in slightly less capital going to the investment target, or the SPV manager can tack on additional charges on top of the investment amount to cover those fees.

As you can see, both the SAFE and SPVs have become relatively standardized to help investors back early-stage founders. At Syndicately we are building the future of SPV infrastructure to make it easy for investors and managers to easily create, execute and manage their SPVs so they can focus on negotiating fair deal terms for all parties and make it easy for their investors to finalize their investment so founders can get back to work and spend less time chasing money around. If you want to learn more about how we help simplify and accelerate your investments, reach out and say hi, we would love to connect and tell you a bit more about what we are building.

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