A special purpose vehicle (SPV), sometimes known as a special purpose entity (SPE), is a subsidiary established by a parent business to protect itself from financial risk. It is a separate entity with its own assets and responsibilities, as well as a separate legal status. An SPV’s legal standing as a distinct company ensures that its obligations are met even if the parent company goes bankrupt. As a result, an SPV is sometimes referred to as a bankruptcy-remote entity.
Legal Status and Benefits of SPVs
A special purpose vehicle (SPV) is a separate legal entity that an organization establishes. It has various benefits, including:
- Separates the risk from the capital.
- Allows asset securitization without disrupting the managerial relationship.
- To raise capital, leverage future earnings.
- Allows for asset transfer.
- Direct ownership of specific assets is provided.
- Provides legal protection.
- Allows for versatility.
- Aids in the sale of real estate.
- Banks and outside investors are drawn in.
- Separates the project into a separate company, limiting any potential claims to that firm solely.
Beginner’s Guide to How SPV Investments Work
Because SPVs are legal entities, their goal can be distinct from the primary activity of the SPV’s incorporators. SPVs are frequently used to delineate and isolate financial risk while also ensuring the continuity of the purpose. Because they are different, the SPV can continue if the organization goes bankrupt or dissolves.
SPVs are also utilized to let investors combine their funds under a single business, allowing these many donors to participate in a single firm collectively. SPVs are often formed as Limited Liability Companies or Limited Partnerships, and dividend payments are given in proportion to member ownership. Furthermore, because each SPV has its own legal standing as well as its own assets and obligations, it can continue to operate even if the parent business has problems.
SPVs are also widely employed in the financial sector. Managing the SPV portfolio and underlying investments in several jurisdictions can be difficult because each country has its own set of strict rules and processes to adhere to. Furthermore, country-specific legislation and compliance might vary substantially and depend on the type of investment. Furthermore, managing ongoing operations and accounting for international SPVs within your fund structure adds to the complexity.
An Example of an SPV Investment
If an investor were to put $20k into an SPV that raises $100k, the investor will receive a 20% membership interest in the SPV. Following that, the SPV makes a single investment in the target company. Despite the fact that numerous investors contributed to the $100,000 investment, it will appear as a single line item on the company’s cap table. If the SPV obtains $1 million in proceeds from a successful exit, the investor with a 20% membership stake will receive $200,000, subject to carried interest. Carried interest is the portion of an investment’s profits paid to the SPV Manager or Syndicate Lead.
Reasons Why Investors Might Use SPVs
- Share startup deals with other investors and receive a share of the deal’s exit value as carried interest on successful transactions.
- Syndicate Leads can strategically offer value to the start-ups they invest in by bringing in other investors who are specialists and/or influencers. This puts them in a position to obtain continuous, proprietary deal flow.
- A string of successful SPV investments can serve as a springboard for the establishment of a VC fund.
- Members can invest as little as $1,000, which is far less than a VC fund or direct investment.
- Investing in a single company rather than a portfolio.
- Members are aware of where the funds will be invested. This is not known in advance with a VC money.
- Choice comes with visibility. Unlike a VC fund, where LPs have no say in the specific investments made by the GP, LPs can choose whether or not to participate in an investment made through an SPV.
- VCs typically charge 2% management fees per year (for a total of 20% over the life of a ten-year fund), whereas SPVs charge different amounts but rarely close to 20%.
- By co-investing alongside the VC, LPs participating in a VC fund can exercise pro-rata rights through follow-on investment in following funding rounds of well-performing enterprises.
- Investors have access to high-quality opportunities when they back skilled lead investors.
Beginner’s Guide to SPV Investment Risks
SPVs have their own legal position because they are independent and separate legal entities. They are frequently referred to as ‘bankruptcy-remote’ because the SPV can continue to operate even if the parent business fails. Using an SPV to aggregate investors implies that each investor understands (and supports) the SPV’s intended purpose – what it will purchase and why, as well as the expected return on investment. An SPV gives direct ownership of a specific asset; the SPV, not the directors or investors, is the official owner. (However, this is also a risk; see below.)
SPVs are very simple to establish and operate, while rules differ by jurisdiction. However, there are inherent hazards associated with the use of SPVs. The process for launching an SPV varies by jurisdiction, making certain regions far more difficult to launch in than others. Implementing an SPV in your own country or overseas can be more difficult than you think because each jurisdiction has its own set of stringent rules and protocols to adhere to. Because SPVs can be used for illegal purposes, they must be handled expertly and diligently to ensure strict compliance.
When utilized by funds or to make an acquisition, the SPV becomes the official owner or shareholder of the transaction, implying that individual investors have no voting rights. Furthermore, because the SPV is a new company with no financial track record, it lacks the parent company’s repute. Loans from reputable financial organizations may be difficult to obtain. They also have less access to money than the parent firm because they do not have the same capital flow.
A Special Purpose Vehicle (SPV) is a separate legal entity created by an organization. The SPV is a distinct company with its own assets and liabilities, as well as its own legal status.
Summing it All Up
SPVs have a number of advantages, including the ability to separate the risk from the capital, allowing asset securitization without disrupting the managerial relationship, leveraging future earnings to raise capital, allowing for asset transfer, providing legal protection, allowing for versatility, assisting in the sale of real estate, attracting banks and outside investors, and separating the project into a separate company limiting any potential claims to that firm solely.