Layered SPVs:
a Practical Guide for Investors and Sponsors
By Shriram Bhashyam
Over the last few years, SPVs have become a critical investment structure for venture capitalists. As SPVs are a more nascent tool in mainstream venture capital, the market is experiencing growing pains and has not yet settled on best practices, particularly for layered SPVs. SPVs are an efficient and fast tool for capital raising, creating broader access to venture capital and facilitating capital formation via syndication. But, like any aspect of early-stage investing, they are not without risks. Those risks compound when SPVs are layered, as has become a common practice. This guide provides practical guidance for navigating layered SPV deals: what they are, why they exist, where they can go wrong, and the practices that make for a responsible deal.
This guide is provided for general informational purposes only. It is not legal, tax, or investment advice, and it does not address the circumstances of any particular transaction. Consult your own counsel and advisors before participating in any SPV.
I. Background
Issuers have real concerns
Companies impose transfer restrictions for legitimate reasons. They want reasonable controls over who is on their cap table and over trading in their shares. Some layered structures are used, intentionally or not, to work around those restrictions, and several high-profile issuers have publicly stated they will not honor unauthorized transfers.
We denounce the use of SPVs to circumvent company transfer restrictions and caution market participants to be vigilant for this type of activity.
II. Common issues and best practices
As a rule of thumb, we advise against leading or participating in a deal where you are unable or unwilling to understand every layer, down to the vehicle that actually holds the asset. If you cannot see to the bottom of the structure, consider passing on the opportunity or be comfortable with substantial risk. Each layer adds cost, complexity, and distance from your rights. In our experience, professional sponsors and market participants tend to treat two layers as the practical maximum. Below, we detail common issues with layered SPVs and offer suggestions for mitigating them.
02
Fee transparency
The risk:
fees multiply across layers, erode returns, and surprise investors who only saw the fees at the top layer.
For example, suppose each of two layers charges 20% carried interest and the underlying shares triple. A direct holder turns $100,000 into $300,000. Through one layer of carry, an investor nets about $260,000. Through a second layer, about $228,000 (36% profit erosion from carry alone).
Same underlying return. Different investor outcomes.
Direct holding
$300,000
One layer of carry
$260,000
Two layers of carry
$228,000
36% profit erosion from carry alone.
Illustrative example: $100,000 invested; underlying shares triple. Each layer takes 20% of the profit remaining after the preceding layer, after return of original capital. Excludes management fees, expenses, hurdles, and other waterfall adjustments. Bars show total proceeds, including original capital.
Add management fees and expenses charged at each layer on the way in, and the gap widens further. While charging fees at multiple layers is not inherently problematic, not disclosing them can be an omission of material information an investor needs to make an informed decision.
The mitigation:
As a sponsor, disclose the fees at every layer of the transaction, all the way to the layer that holds the asset. Sponsors should present the aggregate effect on their investors, not just their own layer’s economics.
Investors can request that the sponsor model a few outcome scenarios that show total fees across layers.
03
Structure and governance
The risk:
Layered SPVs make it more difficult to fully understand your rights and privileges through the chain of vehicles.
The mitigation:
Ensure that you understand the legal structure of every layer and the rights investors hold in each. This includes how liquidity works for your SPV interest and the ultimate asset, who decides when or whether to sell, how rights on underlying shares (such as pro rata rights, anti-dilution protections, and information rights) will be exercised, and what information and reporting you will receive along the way.
The answers to these questions may exist in a variety of documents. For SPVs, these may include the limited liability company agreement, the subscription agreement (transfers of interests), and side letters (negotiated information rights or economic terms). For issuers, relevant documents may include the certificate of incorporation (for rights that attach to a class of shares, such as anti-dilution protections and liquidation preferences), investor rights agreement (for rights such as information rights and reporting), and a ROFR and co-sale agreement (which govern sale of shares, drag-along obligations, and who controls board and voting decisions).
04
Understand how the investment behaves over time
The risk:
Layered structures create dependencies that surface at tax time and at exit.
The mitigation:
Ensure that you have information upfront about the following:
How K-1s will be delivered and by whom. Your K-1 depends on the vehicle above you issuing theirs first, at every layer. Understand the expected timeline and who is responsible at each step.
How and when distributions flow. When the asset is sold, the proceeds will pass through each layer before reaching you.
The waterfall, including how carry is calculated at each layer, and in what order, so you know what a given exit actually returns to you.
III. Ten questions an investor can ask before joining a layered SPV
A sponsor running a responsible process will have clear, documented answers to all of these questions. If they cannot or will not answer in writing, that is a red flag.
01
How many layers sit between my investment and the company's shares, and who manages each one?
02
Who holds the shares at the end of the chain, and what is their relationship to the company?
03
What documented evidence shows that the shares have been acquired, or that there is bona fide, binding access to them?
04
If this is a secondary, who is the selling shareholder, and can they sell under the company's transfer restrictions?
05
Will the sponsor attest in writing that the transaction complies with the company's transfer restrictions and that any required consents or waivers have been obtained?
06
What happens to my capital if the upstream vehicle never acquires the shares? Is there a deadline and a binding obligation to return funds?
07
What are the total fees, expenses, and carried interest at every layer, and what do they add up to for me in a realistic exit scenario?
08
Who decides when the underlying asset is sold, and how does liquidity work for my interest before then?
09
What reporting will I receive, and when should I expect my K-1 each year given the layers above me?
10
How do distributions and the waterfall work across the layers when there is an exit?
Layered SPVs
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