Venture capitalists are increasingly turning to the secondary market to purchase shares of late-stage startups, particularly those in the artificial intelligence (AI) space. This trend is driven by the desire to secure stakes in the most promising startups, but it comes with risks. One method that VCs are using to access these shares is through special purpose vehicles (SPVs), which are financial instruments designed for this purpose. Some of these SPVs have become highly sought after commodities, commanding premium prices in the secondary market. While this may benefit the VCs selling the SPVs, it poses a greater risk for the buyers and raises concerns about the potential bubble forming in the AI startup sector.
When investors buy into a VC’s SPV, they are not acquiring direct ownership of the startup’s stock. Instead, they are purchasing shares of the SPV itself, which holds a certain number of the startup’s shares. This means that they are essentially investing in another investor’s fund, rather than directly in the company. While SPVs are not a new concept, the practice of selling them at a premium is a growing trend that warrants attention. For instance, SPVs holding shares of companies like Anthropic or xAI have been observed selling at prices 30% higher than in the last fundraising round, creating a buying frenzy among investors eager to capitalize on quick profits.
Investing in SPVs at elevated prices could offer smaller VC firms the opportunity to reap future rewards if the companies they invest in succeed. Since these firms may not have the resources to purchase shares directly from startups in fundraising events, SPVs provide an alternative investment avenue. However, the distinction between owning shares in an SPV and owning the actual company stock is significant. SPV owners have limited visibility into the financial health of the company, lack direct voting rights, and do not negotiate terms with the startup. This lack of control and influence over the company’s decisions could leave SPV investors at a disadvantage, especially if a lucrative acquisition or IPO deal is made without their input.
The primary goal of buying shares on the secondary market is to acquire them at a discount to their current valuation. However, purchasing high-priced shares in SPVs goes against this principle, as investors typically aim to buy low and sell high. Despite this, investors are banking on the potential for these AI companies to outperform expectations and deliver significant returns. Yet, the AI sector is characterized by lofty valuations, limited use cases, and uncertain revenue streams, making it a risky bet for investors seeking quick profits through SPV investments.
Investing in secondary market shares of AI startups through SPVs presents both opportunities and risks for venture capitalists. While it provides access to sought-after companies and the potential for future gains, it also entails limited control, reduced transparency, and the possibility of financial losses. As the AI startup sector continues to evolve and attract significant investor interest, prudent decision-making and a deep understanding of the market dynamics are essential to navigate the challenges and uncertainties associated with SPV investments. Investors must carefully weigh the potential rewards against the inherent risks before committing capital to this rapidly changing and competitive investment landscape.