VCs are taking advantage of the secondary market to purchase shares of late-stage startups, particularly those in the AI sector. This trend has led to the emergence of special purpose vehicles (SPVs) as a means for VCs to get a piece of the action. However, the use of SPVs comes with its own set of risks and challenges, indicating a potential bubble in the AI startup space.
While the secondary market provides an avenue for existing shareholders to sell their shares, many VCs are unable to participate as private companies like startups have restrictions on who can own their shares. To circumvent these limitations, VCs are setting up SPVs through which they can sell access to shares to select investors. This approach allows them to control a certain number of the startup’s shares without directly owning them.
Investing in a VC’s SPV does not equate to owning actual shares in the startup but rather shares in the SPV vehicle itself. This distinction means that SPV owners have limited visibility into the financial health of the company and lack direct voting rights over the shares. Additionally, they do not have the same bargaining power as direct investors when it comes to influencing company decisions.
Despite the premium prices attached to SPVs, smaller VC firms see the opportunity to potentially profit if the startups they invest in succeed. However, the success of an SPV investment heavily relies on the future growth and profitability of the startup. If direct investors with voting rights agree to an acquisition that benefits them but not SPV owners, the latter could face losses.
The primary objective of buying shares on the secondary market is to acquire them at a discounted valuation. High-priced shares in SPVs may contradict this principle, with investors banking on the strong performance of the companies to justify their investment. However, the AI sector’s inflated valuations and unproven revenue streams pose considerable risks for investors.
As VCs turn to SPVs to gain exposure to promising startups, the risks associated with this approach are becoming more apparent. While SPVs offer a way for smaller VC firms to participate in the market, the lack of direct ownership and control over shares presents significant challenges. The AI startup ecosystem’s reliance on high valuations and uncertain returns further exacerbates the potential pitfalls of investing through SPVs. Investors must carefully assess the trade-offs and risks involved to navigate this evolving landscape successfully.