Advanced Strategies

As you gain experience in private equity and startups investing, you may be looking at ways to enhance your investments with advanced strategies to maximize returns and manage risks. Here are some additional strategies that can potentially help you accomplish that goal.

Co-Investing with Venture Capital Firms

Co-investing with venture capital (VC) firms is an approach that allows you to leverage the expertise, resources, and deal flow of established VC firms. This can be beneficial because VC firms have extensive networks and access to high-quality investment opportunities that may not be available to individual investors. You also benefit from the thorough due diligence that is conducted by VC firms, which can reduce the risk of investing in poorly performing startups. They can also provide increased diversification and reduced exposure, as co-investing allows for ease of investing in multiple startups and sectors.

Considerations for Co-Investing

  • Identify suitable VC firms: Research firms that align with your investment interests and goals. Focus on firms with strong track records in the industries you wish to invest in.
  • Network with VC firms: Establishing relationships with VC firms can uncover potential co-investment opportunities. Attend industry events and conferences to build your professional network.
  • Join co-investment platforms: Online platforms like AngelList, SeedInvest, and OurCrowd facilitate co-investment opportunities. They often have partnerships with VC firms and offer curated investment opportunities.
  • Perform your own evaluation: Even though VC firms conduct due diligence themselves, you should still conduct your own due diligence to make sure the VC firm and their investments align with your risk tolerance and investment criteria. Carefully review terms and conditions of any co-investment you might become a part of, paying attention to investment size, fees, exit strategies, and other pertinent information.
  • Coordinate with Your Custodian: Work with your SDIRA custodian to ensure that the investment complies with IRS regulations and custodian policies. Provide all necessary documentation to your custodian, including the investment agreement, offering memorandum, and any other required forms.

Secondary Market Investments

Secondary market purchases involve buying shares from existing investors looking to sell their stakes in private companies, rather than directly investing in new shares. This can provide liquidity and opportunities to invest in more mature companies but there are specific considerations to be aware of.

Benefits

Probably most prominent advantage of secondary market investments for most investors is the potential for lower valuations of shares. Secondary market shares are often sold at a discount to their most recent primary round valuation, allowing investors to potentially acquire shares at a lower price. Attractive buying opportunities may present themselves as prices are influenced by current demand for liquidity among existing shareholders.

Another benefit is a reduced holding period, as secondary market investments will be for companies that are further along in their growth cycle with a potentially shorter time horizon to liquidity events like acquisitions, IPOs, or secondary offerings. Since these companies are typically more mature, they will likely have established business models and revenue streams—which could potentially reduce risk. Furthermore, more information is generally available about the company’s performance, financials, and market position, allowing for enhanced due diligence that might not be possible for an early-stage company.

Examples

  1. Employee Stock Sales: Employees of private companies often sell their vested shares to gain liquidity. This can be an opportunity to buy shares in a well-performing company at a discount.
  2. Early Investor Exits: Early-stage investors might sell their shares to lock in returns or rebalance their portfolios. These transactions can provide access to companies that have appreciated in value since the initial investment.
  3. Institutional Sales: Large institutions such as venture capital firms or private equity funds may sell portions of their holdings in the secondary market to manage their portfolios.

Special Purpose Vehicles

Special Purpose Vehicles, or SPVs, are legal entities created specifically for a single investment or a series of related investments. They can allow investors access to larger and potentially more lucrative investment opportunities in private equity and startups.

Benefits

  • Pooling resources: As previously mentioned, SPVs can allow participation in larger deals that might be inaccessible to individual investors. This is because SPVs allow multiple investors to pool their capital, granting them the buying power to negotiate better terms such as lower fees, better valuation, and more favorable exit conditions.
  • Limited liability: Investors in an SPV typically have liability limited to their investment in the SPV, which protects their personal assets.
  • Diversification: SPVs can be structured to invest in multiple assets, providing diversification within the SPV itself.
  • Access to Expertise: SPVs are often managed by experienced fund managers or investment professionals. You will want to conduct research into the background of any SPV manager you are involved with to ensure they are capable of providing the necessary oversight and strategic guidance. The SPV manager also conducts thorough due diligence on behalf of all investors in the SPV.
  • Streamlined Administration: SPVs handle the complexities of investment transactions, making it easier for individual investors to participate. In addition, investors receive consolidated reports and updates from the SPV.

How to Use an SPV with a SDIRA

The SPV is typically structured as a limited liability company (LLC) or a limited partnership (LP), depending on the jurisdiction and specific needs. A detailed operating agreement will have to be drafted by the entity setting up the SPV, which will outline the SPV’s purpose, investment strategy, management structure, and investor rights. Then, specific private equity or startup opportunities must be identified for the SPV to invest in (this could be a single investment or a portfolio of related investments). Conduct thorough due diligence on the target investments, assessing financial health, market potential, management team, and exit strategies.

The SPV will need investors who are interested in participating, each of which must sign a subscription agreement to commit their capital to the SPV. In order to invest with a SDIRA, find a custodian that is familiar with SPV investments and can facilitate the transaction. Provide all necessary documents to the custodian, including the operating agreement, subscription agreements, and any required disclosures. Direct the SDIRA custodian to transfer the committed capital to the SPV’s bank account.

A few additional notes:

  • The SPV manager oversees the investment, handles administrative tasks, and provides regular updates to investors.
  • Ensure ongoing compliance with IRS regulations and custodial requirements. Provide annual valuations and necessary tax documents.

Use Cases

  • Single investment SPV: An SPV formed to invest in a single high-potential startup or private equity deal. This allows investors to concentrate their capital and attention on one opportunity.
  • Thematic SPV: An SPV focused on a specific sector (e.g., healthcare, technology) or theme (e.g., renewable energy). This approach allows for diversification within a particular area of interest.
  • Co-investment SPV: An SPV created to co-invest alongside venture capital firms or other institutional investors. This can provide access to deals vetted by professional investors.

Recap

Here are some advanced strategies for investing in private equity and startups:

  1. Co-investing with venture capital (VC) firms.
  2. Taking advantage of secondary market investments.
  3. Utilizing a special purpose vehicle (SPV).
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