What Is a Special Purpose Vehicle (SPV)?
Here is a thing that happens in startup investing: A group of limited partners (LPs), i.e. investors with limited liability, pools their money together and gives it to a venture capital firm. The VC firm then invests the pool of money into a portfolio of early-stage startups it deems promising, giving the LPs exposure to all of those startups. In some cases, however, LPs don’t want to invest in a portfolio of companies, but rather in one specific company. To facilitate this type of investment, the fund manager might create a separate legal entity called a special purpose vehicle.
A special purpose vehicle, or SPV for short, is a legal entity created by a parent company for a specific purpose. It can be structured in various ways based upon the business objective. In venture capital, they’re usually formed as limited partnerships or limited liability companies (LLCs), for reasons we’ll explain below.
Right off the bat, it’s important to note that venture isn’t the only corner of finance in which SPVs are popular. Corporations may create and operate SPVs to isolate financial risks, avoid certain tax or regulatory requirements, or create more specialized (read: higher-risk) opportunities for investors. This guide will focus primarily on how SPVs are used in venture, but we’ll also explain a few other common uses for SPVs you may encounter as a founder.
- What is a special purpose vehicle?
- How do special purpose vehicles work?
- What are the benefits of an SPV?
- Other uses for SPVs
- Manage your complex cap table with Pulley
What is a special purpose vehicle?
A special purpose vehicle (sometimes referred to as a special purpose entity, or SPE) is a separate legal entity and subsidiary company created by a parent organization.
The distinction between the SPV and the parent organization is extremely important. You might even say it’s the entire point. An SPV has its own specific assets and liabilities, which don’t appear on the parent company’s own balance sheet or in its financial statements. This means that any financial risk the SPV takes on doesn’t carry over to its parent company, and vice versa. If a bankruptcy or insolvency affects one, the other is protected thanks to its separate legal status.
Though SPVs can have a number of different purposes, they oftentimes have something to do with risk and exposure. For example, a company might create an SPV to attract certain equity investors who want to invest in just the SPV’s assets and liabilities (as opposed to the whole company’s).
On the venture side, a VC firm might create an SPV to give LPs the opportunity to invest in a specific target company. Not all LPs have an appetite for the risk that comes with investing in a single company. Others appreciate the chance to invest in a specific company, as opposed to a portfolio of companies built on a general investment thesis.
How do special purpose vehicles work?
Some people hear the words “special purpose vehicle” and immediately think, Hm, sounds a bit sketchy. This reaction probably owes to Enron’s misuse of an SPV for hiding its debt, which contributed to the company’s ultimate downfall in 2001. But SPVs are frequently used in ways that are clean, ethical, and totally make sense in terms of helping to achieve certain business or investment objectives.
The venture capital use case is a good example of this.
How SPVs work in venture capital
Say a VC firm decides to create a fund to invest in a specific company. It may create this fund as an SPV, which it fully manages on behalf of the investors who opt to become limited partners.
An SPV fund is typically structured as a limited partnership or limited liability company (LLC) in which the investors in the fund become members. One benefit of these business structures is that they are able to “pass through” income to their members (who can recognize any business profits or losses on their personal tax returns).
How much of a membership interest does an individual LP have in an SPV? It depends on how much they want to invest. If an SPV raises $150,000 and an LP invests $15,000, they should receive 10% of the total membership interest in the SPV—minus any management fees or reserve fees taken out by the fund manager.
SEC regulations cap the number of investors allowed to join an SPV. If an SPV raises more than $10 million, it can have up to 99 members. If it raises less than $10 million, the number is capped at 249.
How will an SPV appear on my company’s cap table?
Say an SPV decides to invest in your startup’s latest funding round. Will your cap table now have to account for all the various LPs who have a membership interest in the SPV? Fortunately, no. Since an SPV is a single entity, it will only be recorded as a single entity on your cap table.
If a liquidity event occurs and the SPV cashes out on its investment, the members are typically paid back in accordance with their membership interest percentage. The fund manager, or general partner, typically also takes out a percentage of any returned capital as a fee. In Brightspark’s SPV model, for example, about 15% of the returns make their way back to the general partner as a performance or “carry” fee.
What are the benefits of an SPV?
The specific benefits associated with forming an SPV may differ depending on who you are.
For LPs, an SPV can be an interesting way to get exposure to a specific investment opportunity at a relatively low cost. Recall that an SPV can have up to 99 or 249 investors depending on how much it’s trying to raise. That means that an individual investor can get away with investing as little as a few thousand dollars while still getting direct exposure to the company. This may not be possible if they were approaching the company without a pool of capital on hand.
LPs and VC firms alike may find SPVs especially helpful when there’s an investment opportunity that’s exciting but doesn’t align with the firm’s overarching philosophy. Perhaps the risk is too large or the startup is in an entirely different industry. In these cases, it wouldn’t make sense to throw the startup into a portfolio, but it might make sense to treat it as a targeted investment in an SPV fund.
Founders and founding teams may also find SPVs appealing, as taking money from a pool of investors (versus a bunch of different individual investors) means less cap table admin.
Are there any risks associated with SPVs?
SPVs are almost categorically more risky than other types of venture investments—which aren’t exactly risk-free to begin with. Investing in unproven startups can be perilous, which is why VC firms generally build portfolios of many different companies rather than putting all of their eggs into one basket. Since SPVs usually invest in just one company, the chances of going bust may be quite a bit higher.
Any members of an SPV should also keep in mind that they may not have the same benefits or privileges they would get as an individual investor in a company. Voting rights and any voice in the company’s direction aren’t part of the package, as the SPV is treated as the sole shareholder.
Other uses for SPVs
We mentioned above that SPVs actually have a ton of use cases, and equity investment is just one. Let’s review a few other instances in which the legal structure of an SPV may help a company achieve certain objectives:
- Loan securitization: It’s not uncommon for a company to form an SPV for the purpose of securitizing loans. Pools of mortgage loans, for example, may be securitized and moved into an SPV before they’re sold to investors. This can also help protect a company from the credit risk associated with certain loans.
- Joint ventures: If two startups want to dedicate resources toward collaborating on a significant product or project, they might decide to form an SPV as a joint venture. The creation of this separate company could allow them to share resources without going through a complicated merger.
- Property sales: In real estate, a company might use an SPV as a vehicle to avoid paying property sales tax. This typically occurs in instances when the taxes on the sale of a property exceed the realized capital gains from the sale. In such a case, the company could create an SPV that would own the property, then sell the SPV to avoid paying property tax (the company would still owe capital gains tax on the sale of the SPV).
- Asset transfer: In some cases, companies create SPVs to make it easier to package and sell specific assets. Rather than deal with the complication of selling individual assets, a company can sell all of an SPV’s assets simply by selling the SPV in a single transaction.
Manage your complex cap table with Pulley
Perhaps you’ll run into a number of different types of special purpose vehicles as you continue on your startup journey. For now, we think it’s particularly helpful to understand how SPVs work in a venture context. Founders generally come to favor simplicity and minimal admin work when it comes to cap table management, and SPVs can be one way to achieve that.
Speaking of simplicity, Pulley’s cap table management platform makes it easy to manage cap tables of all sizes and complexities. To answer the obvious question: Yes, Pulley is set up to support SPVs. But even if you don’t go that route and want all of your individual small-check investors on your cap table, we can help, because Pulley is the only cap table provider that offers special crowdfunding pricing.
With Startup, Growth, and Custom plans designed to scale alongside your business, Pulley can help you stay on top of your company’s equity picture even as its complexity grows. Schedule a call with us today to learn how we can help.