Club deals and SPVs: what you actually own

When you invest in a start-up through a club deal or a special purpose vehicle (SPV), you do not become a shareholder of the company. You own a share of the vehicle, and the vehicle owns shares of the company. Everything that matters later follows from that sentence: who receives information, who votes, what the investment costs, who signs at the exit and which tax document you get. An SPV is a perfectly good way to hold a stake. It only needs to be recorded as what it is, with both layers visible.

Three structures that are all called pooling

The word covers three different things, and only one of them leaves you as a shareholder.

In an SPV a separate company is set up for one investment: in Germany for instance a civil-law partnership among a few people who know each other, a limited partnership whose general partner is a GmbH or UG, or a GmbH. The investors pay into the vehicle and the vehicle subscribes to the round. On the company's cap table there is one line.

In a trust arrangement (Treuhand) a trustee holds the shares in its own name for the account of the investors. Legally the trustee is the shareholder. Your position is a contract with the trustee.

In a pooling agreement each angel holds shares directly, and the pool members agree to vote together, usually through a pool leader. Here you are a shareholder, bound by a voting agreement.

Before signing, find out which of the three you are looking at. The pitch will say "we pool the angels" in all three cases.

What is your stake in the company?

Say the vehicle holds 4.0 per cent of the company, fully diluted, and you hold 6.25 per cent of the vehicle. Your indirect stake is 0.25 per cent. That number is nowhere in the company's documents. It exists only as the product of two percentages from two different sets of papers, and both change: the first with every financing round, the second if the vehicle takes in more money for a follow-on.

Who gets information, and who votes?

In a GmbH every shareholder may demand information about the company's affairs and inspect its books (§ 51a GmbHG). The shareholder is the vehicle. The right is exercised by whoever manages it, typically the lead investor.

Your own rights are against the vehicle. If it is a limited partnership, § 166 HGB gives you a copy of the annual accounts, the right to inspect the books to check them, and information as far as you need it to exercise your membership rights; the partnership agreement cannot exclude this. But these are rights concerning the vehicle's affairs. What reaches you about the company, how often and in what form, is decided by the vehicle's agreement and by the lead's diligence.

The same applies to votes, to pre-emption rights in the next round and to the decision to sell. Three questions are worth asking in writing before the money moves. What reporting does the lead pass on, and when? Who decides how the vehicle votes: the lead alone, or the investors by majority? And if the company offers the vehicle its pro-rata share in the next round, how is that funded: a call on existing investors, a new vehicle, or not at all?

What do fees and carry do to the return?

A vehicle has costs the direct investor does not have, and usually a profit share for the lead. A worked example with invented figures:

Sixteen investors put EUR 400,000 into a company through an SPV. Setting up the vehicle costs EUR 8,000, and accounts and tax filings cost EUR 3,000 a year for five years. The investors pay these EUR 23,000 on top, so EUR 423,000 goes in. Your share is 6.25 per cent: EUR 25,000 of investment and EUR 1,437.50 of costs.

After five years the company is sold and the vehicle receives EUR 1,600,000, four times the invested amount. The lead is entitled to a carried interest of 20 per cent of the profit above the capital contributed. The profit is EUR 1,177,000, the carry EUR 235,400. EUR 1,364,600 is left for the investors, of which EUR 85,287.50 is yours.

The company returned 4.0 times. You received 3.2 times what you paid. That is a fair price if the lead found the deal, negotiated the terms and sits on the advisory board. It is the number to compare with what a direct ticket would have required, and to record from the first day: your cost is EUR 26,437.50, not EUR 25,000.

What happens after the first round?

Three situations show whether a vehicle was set up with care.

A down round or a recapitalisation asks existing shareholders to put in more or be diluted heavily. The vehicle can only follow if its agreement provides a way to raise the money. Not every agreement does. What a down round does to early shareholders then happens to the vehicle as a whole.

At an exit the buyer deals with the vehicle. Part of the price is often held in escrow or paid later, so the vehicle must stay alive, file accounts and distribute a second time. Someone has to do that work two years after the party.

And the lead may lose interest, change jobs or die. A vehicle with one manager and no successor rule has a problem its investors notice late. This is one of the positions heirs find hardest to trace, as we described in the piece on succession.

Regulation and tax in outline

Whether a vehicle is an investment fund under the German Capital Investment Code is the organiser's question, but it is worth knowing where the line runs. BaFin's interpretative letter of 14 June 2013, last amended on 9 March 2015, ties the criterion of raising capital to commercial solicitation of investors. An investment club in which no member was commercially solicited does not meet it. A vehicle marketed to a wider public is a different case. Ask the organiser how the structure was assessed.

For tax the legal form decides. In a partnership that only manages assets, the assets are attributed to the partners pro rata (§ 39(2) no. 2 AO) and the income is determined in a separate, uniform assessment for all partners (§ 180 AO). You then depend on the vehicle's filing for your own tax return, and a late filing by the vehicle is your late figure. A GmbH as vehicle is taxed itself, and you are taxed on what it distributes. Convertible loans granted through a vehicle add their own questions. None of this is tax advice; the vehicle's adviser and yours should agree on the treatment before the first exit, not after.

How to keep the look-through

Record two things for every such investment and keep them apart.

The first is your position in the vehicle: its name and legal form, your percentage, what you paid including costs, the agreement, the lead's contact, and the carry terms.

The second is the vehicle's position in the company: number and class of shares, the round, the price per share, the liquidation preference of that class, and the cap table after each later round.

Your value is then the vehicle's share of the company's equity value, less the carry that would be due at that value, times your percentage. It takes four numbers, and three of them come from documents that are not addressed to you. So the last item on the list is a standing request to the lead: after every round, send the updated cap table. A lead who agrees to that in the vehicle's agreement has answered most of the questions above.