Special Purpose Vehicles (SPVs) are also commonly referred to as Special Purpose Entities. They are commonplace in the world of finance as so-called “bankruptcy-remote entities”: used to isolate or securitize assets, and held off-balance sheet. In the wake of the 2008 financial crisis Special Purpose Vehicles might have gotten a bad reputation, but they have made a recent resurgence in a new capacity: as tools to simplify startup financing.
Despite the scepticism, Special Purpose Vehicles can be very valuable in the right circumstances: after all, it is merely a tool. One that can be used for good or evil, much like anything else in the world of finance. In this article, we share how Special Purpose Vehicles can be useful and valuable, both in a startup context and other contexts, and explain how to set one up.
Special Purpose Vehicles Explained
A Special Purpose Vehicle is an autonomous legal entity – usually an LLC, although they can be set up as trusts or partnerships as well. Much of the advantage that Special Purpose Vehicles offer is related to the simplified management of investments, assets, or a transaction: for that reason, SPVS are ideally incorporated with uncomplicated management and governance structures.
It is created to fulfill a narrow, specific, and/or temporary objective. Usually, this means that a Special Purpose Vehicle is created for a specific transaction, investment, or business acquisition. In the context of startup financing, it is used to pool investors into a single entity. This means that investors each buy a percentage membership of the Special Purpose Vehicle, rather than investing directly in the startup.
The Benefits of Special Purpose Vehicles
Special Purpose Vehicles are traditionally created to isolate the parent company from financial risk, and this is also the most obvious benefit of SPVs. It protects against bankruptcy and creditors: the parent company can make high-risk investments without endangering its own solvency. In addition to lowering the parent company’s financial exposure, Special Purpose Vehicles can help parent companies obtain higher credit ratings, lower funding costs, and accordingly greater financial flexibility.
Another significant benefit of Special Purpose Vehicles is that they are faced with less stringent regulatory and statutory requirements, and therefore have more freedom to operate. Because they can be off-balance sheet, they allow for confidentiality when a company wants a specific transaction or project to remain hidden from competitors.
In the context of startup financing, Special Purpose Vehicles allow for a simplified cap table. It allows the startup to deal with only one entity, and not with large numbers of individual investors. Additionally, Special Purpose Vehicles serve to limit investors’ ability to control and determine the day-to-day operations of the startup.
How to set up a Special Purpose Vehicle
Setting up a Special Purpose Vehicle can seem deceptively simple. The first step, of course, is to decide on the entity type or corporate structure. Although a Special Purpose Vehicle can take any corporate structure, it is most commonly incorporated as an LLC.
The next step is to determine the jurisdiction in which to incorporate the Special Purpose Vehicle. If you are utilizing a Special Purpose Vehicle for startup financing, it would be wise to incorporate it in the same jurisdiction as the startup – in most cases that would be Delaware. If the Special Purpose Vehicle is being set up for a specific project or transaction, you should consider the state in which that project or transaction takes place: in such cases the decision of where to incorporate will have significant tax and even regulatory implications. It is best to get legal advice before making a decision in this regard.
Once you have decided on your entity structure and jurisdiction of choice, incorporation is fairly simple. Most states allow for an easy registration process in which you need to indicate ownership and management of the Special Purpose Vehicle and draft its governing documents. The powers of the SPV will be limited to the purpose for which it was created. For this reason, it your constitutive documents are worth careful consideration.
Finally, you will have to fund the Special Purpose Vehicle in whichever way suits your purposes. The only caveat is that an independent third party must pay for a percentage (generally a minimum of 3%) of the equity investment.
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