On Friday, Jessica wrote about how special purpose vehicles, SPVs, are good for VCs and for companies looking to maximize valuations.
I think there’s another interesting angle that’s been coming up in discussions of late: how technology, coupled with the intersection of Sarbanes-Oxley and the JOBS Act, is turning VCs shopping SPVs into investment bankers.
As the son of a 30-year veteran TMT banker, and as someone who has helped put together a few SPVs, this is a pretty interesting and personal realization for me.
In the IPO heyday of the 1980s and 1990s, investment bankers marketed IPOs of early-to-growth stage companies to accredited investors to raise tens or hundreds of millions of dollars. Now VCs, via SPVs are doing exactly the same thing—at a similar scale and with similar dynamics.
Special purpose vehicles are cropping up as companies push back their IPOs. But they have some of the same dynamics as going public.
To understand why, it is worth quickly reviewing regulation and technology changes over the last ten years.
On the technology side, increasing communication speed and reach has brought more people into the market for private securities. Tools like e-signatures (DocuSign) and data rooms (Merrill) allow a small team to complete and manage complicated financial transactions with lots of different parties at low cost. These technologies strip out what was the overhead of investment banking in the 1980s: airplanes, FedEx and room-sized fax-machines.
On the regulation side, Sarbanes-Oxley passed in 2002. At the time, I distinctly remember my father explaining to me how the new legislation would make it very unappealing for many companies to be public. The new reporting standards would dramatically increase the annual compliance costs of being public. The pain and risks associated with being on a public board would increase, making it harder to attract senior talent and great directors.
For the 10 years between 2002 and the 2012 passing of the JOBS Act, growing technology companies were frustrated by SOX but had limited alternatives to being public. The private capital markets were highly constrained by rules like a relatively low maximum 499 shareholder count before companies had to start disclosing more financial information.
The JOBS Act, in 2012, lightened some of the IPO process requirements for growth companies by lifting the maximum shareholder count to 2,000 and allowing non-accredited investor employees to be shareholders; thus, technology companies could stay private for much much longer, and perhaps forever. So, the JOBS Act, which was partly designed to make being a public company easier, seems to be, at least for now, making it much easier to raise big sums of money from lots of investors for longer.
These structural changes prompted financiers to change their approach. Traditional investment banks shifted more attention to private placements for technology companies in the billion dollar club.
At the same time, VC firms—most notably in my mind Andreessen Horowitz—rapidly staffed up and created multiple lines of business to serve clients, similar to the process investment banks went through before they all went public.
Another major similarity between the IPOs of the past and the SPVs of today is the people buying them. The investors buying into SPVs look a heck of a lot like the wealthy, connected people who were buying into technology IPOs in the 1990s. Access is the currency now, as it was then. People buying into deals also have similar complaints about access to information about these startups, questions around accounting practices and more.
Even the mechanics of SPVs vs. IPOs make them feel like cousins. Both usually have a lead dealmaker who prices things. Then the company chooses a syndicate of banks or funds that spread out the round and sign up for different allocations based on what they think they can place.
When you adjust for the risk associated with the fact SPVs target earlier-stage companies, the actual economics of IPOs versus SPVs are pretty similar.
While investment banking has always been a rainmaker-driven business, where individual people and personalities drove the majority of the business for firms, the leverage from technology is now allowing small teams and one-man shows to have even more power. As a result, you see more individual stars running their own SPVs compared to investment banks or companies.
Of course, IPOs and SPVs pay the people who organize them differently. Investment bankers used to take a portion of capital raised, it was around 7 percent back in the day and the economics have generally gotten worse. For SPVs, VCs tend to take 10 to 20 percent carry on the upside.
But even though the carry is technically higher, when you adjust for the risk associated with the fact SPVs target earlier-stage companies, the actual economics of IPOs versus SPVs are pretty similar.
Finally, and interestingly, the average investor is getting exposure in these later-stage private companies just like they did in the public IPOs of the 1990s. The big institutional investors might not be entering these deals directly via SPVs (nor did they necessarily via IPOs back in the day); however, as more and more companies stay private for longer, the Bogleheads running index funds—investors who generally believe in having broad exposure to the entire market—are getting into private deals.
This is all landing us in an interesting place. Companies that are private are getting really big and really highly valued. The relevance of the public market and the equality of access that it stands for is sadly declining. There are interesting questions about where liquidity for investors will come from in the future. The lower multiples in the public market vs. the private market make it hard for a lot of these companies to consider IPOs, and even harder for public companies to acquire private technology companies.
Perhaps the answer is that these companies will stay private effectively forever. Traditional reasons for going public, like access to currency for acquisitions and liquidity for investors, can be satisfied by an increasingly efficient and vibrant private market for a long time to come. Perhaps the only reason that remains for going public is political: to turn your shareholders into citizen voters who can support your agenda in Washington. (This will be increasingly important for Uber and Airbnb, which you can bet will go public.)
In the end, I am personally excited about SPVs. I believe we live in a time when really great companies are getting built, and I think SPVs are good for all parties. They can provide relatively inexpensive capital for companies and give individuals access to deals they want to participate in.
Perhaps SPVs will also satisfy calls for “slower” equity markets that aren’t traded as actively and are therefore less volatile to day-to-day news and quarter-to-quarter thinking.
I do, however, think it is worth keeping our eyes wide open about the fact that SPVs aren’t really anything new. Investors, in that respect, should do their diligence and make sure they are comfortable with what they are investing in. SPVs are very much a cousin of IPOs—and that effectively makes a lot of VCs into card-carrying investment bankers whether they like it or not.