One of the most fundamental challenges facing a start-up company is how to find investors. After all, a start-up needs capital in order to develop its product, hire employees, market itself, and hopefully, grow. As a result, many founders seek investments from numerous sources including friends, family, outside investors, and institutional funds. The number of investors can become lengthy which leads to an interesting question – Is it possible to have too many investors?

When an investor provides equity to a company, they acquire an ownership interest. As a result, they are entitled to certain benefits such as decision-making rights and access to financial information. A founder must deal with each investor’s requests and demands while still trying to operate a fledgling company. As the investor list grows, so too will the requirements. It could become very challenging to focus on the company while also attending to all of the investors.

One common structure to address these issues is through a Special Purpose Vehicle (“SPV”). A SPV is a legal entity that allows multiple investors to pool their money to invest in the start-up. Each investor buys an ownership in the SPV rather than investing directly in the start-up. The SPV, in turn, invests in the company. However, there are pros and cons to an SPV for both the start-up and for individual investors.

For the Start-Up Company

A SPV greatly simplifies the company’s capitalization table. Imagine that instead of having to list forty owners that each own 1% of the company, there can be one SPV that owns 40% of the company. Further, the founder would only deal with one entity rather than forty individual voices. On the other hand, this arrangement may afford the SPV with a significant ownership interest in the company. As a result, the SVP can exert a much louder voice in the direction of the company.

For the Investor

As the corollary to the above point, a SPV may provide an individual investor with much more leverage with the company than the investor would otherwise have on its own. In using the above example, instead of having a 1% ownership interest, the investor effectively has the same rights as a 40% owner while still contributing the same capital amount as before. The SPV, however, adds a level of complexity and cost as there will be agreements setting forth the terms and management of the SPV itself. An investor will not have individual rights in the company anymore. The SPV will also likely be managed by a third party so an investor will not have direct access to the company.

Whether you are looking to  start a company or invest in one, there are advantages and disadvantages to a SPV that need to be weighed carefully. Contact one of our Mergers & Acquisitions and Business & Corporate attorneys today to discuss how you may be affected by these factors.