SPVs are often considered complex given their assumed nuances and components. However, they are becoming the new tool used in investing, so it's important to understand everything you need to know about SPVs.
SPVs or Special Purpose Vehicles are hardly a new tool in the world of investing. An SPV is a standalone legal entity formed for the sole purpose of pooling capital from investors and then investing in a target asset.
Special Purpose Vehicles are an incredibly versatile investment entity used by a number of different investors and fund managers. For each group of individuals, there is a specific set of unique benefits that SPVs offer.
In venture investing, SPVs allow a series of smaller investors to pool capital and make a single, larger investment, or meet a larger investment minimum (if the minimum to invest is $250k, you can get 10 $25k checks together).
For founders, their cap table remains clean as the SPV appear as a single-line item on the cap table instead of 10 separate entries.
For deal managers, SPVs can be configured to capture management fees and carried interest just like a VC or PE fund if you are looking to be compensated for your work in pulling the deal together. Each SPV is an LLC and can have its own operating agreement where you can write these terms in.
BENEFITS FOR FUND MANAGERS, ANGEL INVESTORS AND SYNDICATES, AND DAOS
- Expedite SPV formation and execution, enabling them to be agile in today’s hyper-competitive funding environment.
- Improve efficiency of funding experiences for LPs / Members and Founders.
- Keep LPs / Members updated on portfolio companies and make ongoing SPV management a breeze.
BENEFITS FOR FOUNDERS
- Simplify cap table into a single line instead of 10, 20, or 50 individual investors.
- Streamline investor relations as the SPV organizer becomes a single point of contact for LP updates.
- Simplify access for non-traditional investors (Family Offices, Angels, and High Net Worth Individuals)
The terms, Special Purpose Vehicles (SPV) and Special Purpose Entities (SPE), are used interchangeably, with the distinction that SPEs are often a trust or company. While SPVs and SPEs sound complicated, they're actually quite simple when configured and administered properly.
Before diving into the process behind how an SPV is created, we must briefly define these four key terms.
- Disregarded Entity: entity that is ignored for tax purposes
- Operating Agreement: The operating agreement is a largely standardized document outlining the intended reason for the existence and operation of the LLC.
- Private Placement Memorandum (PPM): note that states that the investor, who signs the document, has reviewed all deal information and terms, and is comfortable with what the SPV intends to purchase or invest.
- Subscription Agreement: accordance that allows SPV members to commit the capital they would like to put toward the SPV
Often, referred to as "disregarded entities", SPVs are structured as an LLC, typically a Delaware LLC, with pass-through taxation. This simply means that the income of the LLC itself is not taxed, and any income or capital gains taxes generated from the SPV LLC is passed along to the owners of the LLC.
Once concluded, the Operating Agreement and Private Placement Memorandum (PPM) are often created in tandem to outline the purposes and uses for the SPV. For all parties involved, Operating Agreements ensure proper communication, PPMs provide confidence and security, and Subscription Agreements allow SPV members to commit the capital they would like to put toward the SPV.
- Target Company
- Manager / Sponsor
- Closing Agent
This company (or more than one company) is the organization that the SPV funds.
Typically an LLC, the SPV and the target company conduct a transaction, perhaps with other co-investors at the same time.
The SPV receives either equity as a single entity or a debt note as the holder. For the target company, the administration is easier since there is a single entry and a single point of contact for its members.
Manager / Sponsor
The manager and/or sponsor of the deal is the one putting the syndicate of members or co-investors together.
The sponsor works with the target company to form a deal and then will "syndicate" the investment capital allocation to investors.
Those co-investors will become members of the SPV entity whom managers can charge.
Members are considered "co-investors" into the SPV, and join through their capital contributions to the SPV.
They follow the decisions that the Manager makes and may have flow through losses/income that will result in tax filings for the members.
During the initial funding, the Closing Agent ensures that the documentation and reporting requirements are completed.
Post close, the closing agent ensures any state or tax filings are completed, handles any ad-hoc post close SPV events, and is there for the wind down of the SPV, which may result in distributions for the members.
KYC, or Know Your Customer, is an important set of guidelines that anyone facilitating a transfer of money must follow. It is designed to protect against money laundering and other illegal financial activity.
To comply with KYC guidelines, a money transmitter must collect certain information from its customers.
This includes full name, date of birth, residential addresses, and identification information, such as a passport or driver's license.
The money transmitter must verify the customer's identity using independent sources.
The KYC process allows parties to freely move funds given the assurance that everyone involved has been KYC'd and verified.
Whether an emerging manager looking to build their portfolio and build a strong relationship with a potential LP base, or an existing fund looking to capture an opportunity outside of the fund's scope, SPVs are becoming the go-to vehicle to help pool capital and execute investment opportunities by both parties. Given their significance, it is incredibly crucial to understand the different components and factors that make up an SPV.