Special Purpose Vehicles (SPV) or Special Purpose Entities (SPE) have been commonly used in the world of finance for decades. In the aftermath of the financial crisis they may have faced increased scrutiny, but these company structures have made a resurgence in a new role: securing startup financing.
In the context of startup financing, a Special Purpose Vehicle can be used as a funding structure (usually registered as an LLC) by which all investors are pooled together in a single entity. Often, it is used to pool together investors that contribute under a given investment threshold.
In legal terms, this means that these investors each buy a percentage membership in the SPV LLC, rather than investing directly in the startup. An SPV’s legal powers are limited to the purpose for which it was created – when that purpose has been attained, the SPV must be terminated. Once created, an SPV must be managed and owned separately from the startup and operated as an independent entity: managing its own funds, decisions, risk, and capital. It is possible to set up an SPV so that it requires minimal or even no management decisions, however.
This arrangement offers some significant advantages for both investors and startups.
Advantages of SPVs
SPVs make it easier for startups to simplify their cap table. Rather than dealing with large numbers of individual investors, the startup can deal with only one entity. Another great advantage for startups is that investors do not have a direct say in the startup’s day to day operations. The only shareholder from the startup’s perspective is the SPV. This means that opinions, decisions and inputs from shareholders have to reach consensus and reach the startup formally via the SPV. A final benefit for startups is that SPVs might create the possibility of raising more funds by making investment opportunities more affordable and less risky to a larger pool of prospective investors. And that, in short, is why investors like SPVs as well:
From investors’ perspectives, investment via SPVs usually allows for lower investment minimums. Investors that would not have been able to invest directly in a private company, would be able to invest in an SPV. The second significant advantage for investors is that each individual investor’s personal liability and risk of losses is limited to their percent of ownership of the SPV. LLCs will pass profits and losses on to their members in proportion to their ownership percentage.
Disadvantages of SPVs
The biggest downside for investors is that they do not have a direct individual right in the startup. They are also subject to the SPV terms and agreements. Essentially, investors put their money in the hands of the SPV managers, and that can in itself be a risk.
For a startup, creating an SPV entails additional costs and increased legal regulations and requirements. Whether or not all of that is worth it will, eventually, depend on the nature of the startup and the types of investment needed.
Entrepreneurs have options when it comes to fundraising. Attorneys providing legal fundraising services can advise you about the various benefits and liabilities of these financing options. Contact LawTrades today for affordable and convenient expert advice.