Syndicates Masterclass: Deep Dive on Structure

Here’s a step-by-step of doing a deal with an SPV for your syndicate. The core components of doing an SPV cover: Legal, Tax, Compliance, Administration, and Accounting. As you will see, despite the simplicity, speed, and cost-effectiveness of SPVs relative to a venture fund, there’s still a lot there. Fortunately, there are service providers like Assure that have brought tech to give you streamlined process for doing all of this. Easy for you and for your LPs to get into these deals. That said, it’s good to know what’s under the hood, and there are important decisions you’ll have to make, strategies to employ, etc. The more you understand the better, as you’re ultimately the lead putting the inputs together for the Assure SPV platform.

The process of running an SPV can be broken down into three parts: 

  1. Closing – Setup, documentation, onboarding and purchasing the asset
  2. Finalizing – Securities filings, Capital account statements and finalization of the investment
  3. Post Close – Taxes, corporate actions, exits, distributions and wind down

Closing

  • Create the SPV Entity (LEGAL): The very first step or task is the set up the legal entity which will be an LLC or LP structure – both are very similar.  If you want a primer on the difference, check out this article on LLC vs. LP. Additionally, there’s a podcast episode on an assessment of the two.Entities are simple legal structures and are state-specific.  Most pick Delaware because it is considered by some to be the most flexible type of business entity in the world.  Many states have mirrored Delaware’s flexibility and advantages but Delaware maintains its reputation and standing as the place to register your entity.
  • Hire a registered agent: When you set up an entity, the state you select, for example Delaware or Utah, requires you to hire a registered agent.  A registered agent is the liaison between your company and the state. Your registered agent is responsible for making sure you receive your tax forms, notices from the Secretary of State, and any service of process you may receive if someone sues your entity. Hiring a registered agent is required by law.  Without a registered agent, the state will not set up your entity and if your registered agent resigns and you fail to replace them, the state will void your entity. It usually takes 1 – 14 days to set up an entity and hire a registered agent.
  • Documentation (LEGAL):  An entity that has been set up is basically an empty shell.  Legal documents govern how this entity behaves, and the rights and rules of those that belong to it.  We are talking about capital-raising SPVs so the documents that we need include an Operating Agreement, Private Placement Memorandum and Subscription Agreement. Operating Agreement governs the relationship between all of the investors and managers of the SPV.  Subscription Agreement covers the committing of capital to the SPV by the investors.  The Private Placement Memorandum (also referred to as a PPM) advises all prospective investors that they face a high probability of losing all of their invested capital, so they may not want to invest.
    • Documentation for your SPV is very important, so much so that we are dedicating one of our sessions to this topic alone.  Documentation is a large reason that a traditional VC Fund is so expensive and slow-moving and why an Assure SPV is so much cheaper and faster.  
  • Obtain an EIN Number from the IRS (LEGAL/ADMINISTRATION): A capital-raising SPV needs a tax ID number for two key reasons.  The first is because the entity will need to file a tax return and deliver K1s to its investors.  The second reason is that if a bank account is required to aggregate all of the investors’ capital, an EIN is necessary.  
  • Opening a Bank Account (ADMINISTRATION): Although not necessary, most capital-raising SPVs need to aggregate the funds from its investors into a bank account before sending funds on to the target company or completing the asset purchase.  Entity creation certificates (1 & 2), entity documentation (3) and entity EIN number (4) are all necessary to establish a bank account. Now we get to the fun part which is commonly referred to as “herding cats”. 
  • Onboard Investors (LEGAL/COMPLIANCE/ADMINISTRATION):  Now that the entity is set up, documents have been finalized and the bank account is opened, it is time to have investors invest.  Investors invest through two specific actions: first, filling out and signing the documents; second, wiring their funds to the bank account.  Investors need to sign the operating agreement.  They also need to fill out the forms and sign the signature pages in the subscription agreement. 
  • Signing the operating agreement, the investors are agreeing to the direction, rights, rules and restriction of the SPV as documented in the agreement.  By providing the requested information and signing the subscription agreement, the investors are providing the SPV with the following: 1. who or what entity is signing up; 2. how much they are committing to invest; and 3. all of the relevant detailed information, including address, phone number, tax id numbers, entity type, etcetera. 
  • Once an investor has signed all of the documents and wired their funds, they are considered onboarded.  Onboarding covers a number of various tasks and expertise, like: reviewing subscription documents for completeness and answering investors’ questions regarding the documents. KYC/AML checks, accreditation verification and complying with investor limits and a variety of other rules.  Additionally, this step covers working with investors (herding the cats)  and answering their questions such as: I signed, now what? Did you receive my wire? When will the deal close? Has the deal closed yet? Now has the deal closed? Why haven’t the documents been countersigned yet?, and so on…Finally we are at the last step of the “Closing” portion. 
  • Signing the Purchasing agreement and wiring funds to the company (LEGAL and ADMINISTRATION): Purchasing the asset is the entire reason this SPV was set up.  Once all of the investors have been onboarded (which means signed and wired), it is time to use those funds to purchase the asset.  The nuances of “purchasing an asset” depend on the type of asset.  When investing in a startup, there is some sort of purchase agreement that is signed by the manager of the SPV. Then the funds are wired.  

Finalizing:

Finalizing begins with Getting all of the SPV investors their Capital Account Statement (ADMINISTRATION): Now that the investment has been made, the investors want a receipt that recognizes their commitment to this SPV and tells them a bit about the SPV and everyone who participated.  A capital account statement is this receipt.

  • Build and save the Cap Table for the SPV (ADMINISTRATION): For proper record keeping and – more importantly –  for taxes, distributions and other activities, the managers of the SPV need to create a cap table listing all of the investors and all of their relevant information.  This cap table will be used and referred to over and over again.
  • Complete and File your Security Filings to the SEC and relevant states (LEGAL and COMPLIANCE): When you use a capital-raising SPV to pool capital in order to invest in private assets, the Securities and Exchange Commission (SEC) have defined those actions as “selling securities” and state security and exchange commissions also define said behavior as “selling securities.”  If you sell securities, you need to comply with filing and fee requirements.  So, there are two buckets of compliance requirements — federal and state.  To comply with federal security laws you need to file a Form D with the SEC. To comply with state security laws, you need to file blue sky filings and usually pay a fee, with every state in which an investor that participated in the SPV resides. 
  • Circle back and make sure everything is Finalized for the investment (ADMINISTRATION): Finalizing is good housekeeping, where you take the time to double-check the documents and make sure you fully executed these documents.  Many times, when making a private asset investment, an investor (such as a capital-raising SPV) will wire funds and sign documents before the group raising funds for their startup or project finish the fund raise – and deliver countersigned documents and final drafts to investors.  If you don’t double-check and make sure everything is in order, you can go years before realizing that investors never received a fully executed document package.

Closing:

Part three of a Capital-raising SPV are all of the tasks that pop up on an inconsistent time frame stretched out over several years:  For example: taxes, future financing rounds, corporate actions, distributions and wind-downs. The first task in the third part of an SPV is Taxes.  You will need to prepare and file Taxes and deliver K1’s to your investors (when needed) (TAXES):  Capital-raising SPVs, according to the IRS, are partnership tax returns.  Partnership tax returns only need to be filed when there is a taxable event.    Assuming your SPV had a taxable event, a form 1065 needs to be prepared.  This generates K1s for each investor.  The 1065 is filed with the federal government and any applicable states – and each investor gets a K1. Capital-raising SPV tax returns are far less complex than returns for companies that are an ongoing concern. Still, there is a seemingly endless list of rules and requirements for capital-raising SPVs that need to be understood and complied with.  We have dedicated two sessions of this Masterclass conference to taxes.  Moving on,

  • Prepare and distribute financials for the SPV (ACCOUNTING).  Preparing financials is a maybe step for a capital-raising SPV.  The need for financial statements to be prepared and shared with the investors depends on a few factors, the most influential of these is the asset that the SPV invested into.  If the asset generates frequent cash flow, then we should seriously consider producing financial statements.  If the asset, like investing into a startup company, does not produce the need for frequent distributions, then financials statements are not necessary and we can consider them as optional. 
  • Participate or ignore Pro Rata Allocations when future financing rounds occur (LEGAL/COMPLIANCE/ADMINISTRATION): This action is startup company-specific.  Per our example, when a startup company grows and raises more funds, some of the early investors will have the right to invest more capital in the company.  These rights are called pro-rata rights. Tune into our Pro Rata masterclass in this conference to learn more about Pro Rata rights.  
  • Deal with Membership Transfers (LEGAL/ADMINISTRATION/COMPLIANCE and TAXES): It can be several years between onboarding investors and an exit, especially when investing into startup companies.  Investors’ lives move forward and sometimes they need to transfer their investment from one entity to another. This is called a membership transfer.  Membership transfers require legal documentation and cap table updates. It is considered a taxable event so a tax return and K1s will be generated.  We are not referring to selling a membership interest but simply transferring one.  Some examples include:
    • Investing as an individual and then setting up an LLC to aggregate all of your investing activity so you want to transfer this SPV investment into your new LLC entity
    • Divorce: You may need to split the asset into two –- in other words, transfer half to a former spouse
    • Trust: Setting up a trust in order to pool all assets into that trust, and
    • Death: If an investor passes away, the asset needs to be transferred to their heirs
  • Maintain the Entity each year so it doesn’t get canceled (ADMINISTRATION): Annually the entity needs to be maintained through the payment of fees.  We don’t want our SPV entity to be canceled.  Next,
  • Manage all of the Corporate Actions that require your attention (LEGAL/TAXES/ADMINISTRATION and maybe ACCOUNTING): Corporate actions occur when the asset the SPV invested in requires or desires its investors to vote on one or more matters. Using our example of investing in a startup company, there is a long list of matters that may arise that will be presented to the SPV, as an investor, to sign off on.  These matters vary in their level of importance. The request generally comes in the form of legal documents and the results of the action may impact the value of your investment — either positively or negatively.  Here are some examples of corporation actions when investing in a startup company.
    1. Shareholder resolutions
    2. Shareholder meetings
    3. Changes to the board
    4. Company restructuring
    5. Asset sale
    6. Stock splits
    7. Round extensions
    8. Bankruptcies
    9. IPOs
    10. Acquisitions
    11. Other
  • Exits are considered corporate actions and the reason for making the investment in the first place.  An exit is the very broad term for all outcomes, both positive and negative for a private asset investment.  Bankruptcy, ABC, Shut down, Acquisition, and IPO are the most common exits.   
  • Collect and send out Distributions to your investors (ADMINISTRATION and TAXES and if applicable ACCOUNTING):  Distributions from a startup company investment usually come in one of two forms: cash or shares.  When distributions occur – and hopefully they occur often and in large amounts – the SPV needs to distribute the cash or shares, in the correct amounts, to the correct investors. This is a moment of truth for your administrative activities. Was the cap table correct on day one? Did it get correctly adjusted when pro-rata allocations were exercised and when membership interests were transferred?   The cap table is vital in getting distributions correct.  Investors get upset when they receive less than they should or when they receive some other investor’s amount instead of their own. Distributions will affect the tax returns and, if applicable, also the financials. 
  • Shutting down the SPV is usually called a Wind Down (ADMINISTRATION AND TAXES):  When the asset has fully liquidated and the SPV no longer serves its purpose, the SPV needs to be shut down and a final tax return needs to be filed. The IRS needs to be told that the entity is finished, and they shouldn’t expect to see any future returns.This is the anatomy of a capital-raising SPV. Done. That probably felt like a lot but even though it may feel a bit overwhelming on its first pass, you can get your mind around an SPV and thousands are flocking to this structure because it can be understood. Assure can administer and if needed manage the SPV but you can be as knowledgeable about SPVs as anyone else.