Special Purpose Fund: A Guide To Investing Wisely

Special Purpose Vehicles (SPVs) are separate legal entities created by a parent company for a specific purpose. They are often used to isolate financial risk, avoid certain tax or regulatory requirements, or create more specialised opportunities for investors. SPVs are typically formed as limited partnerships or limited liability companies (LLCs). They are attractive to investors as they allow them to pool their capital and make a single, large investment in a company, with lower fees and higher accessibility than a traditional VC fund. However, it is important to note that SPVs are riskier than other types of venture investments due to their lack of diversification.

Characteristics of Special Purpose Vehicles (SPVs)

Understand the basics of Special Purpose Vehicles (SPVs)

A special purpose vehicle (SPV) is a separate legal entity and subsidiary company created by a parent organisation for a specific purpose. SPVs are also referred to as special purpose entities (SPEs).

SPVs are created to isolate financial risk, allowing the parent company to undertake a risky project while protecting itself from severe failure risks. SPVs also enable the securitisation of debt, providing investors with assured repayment.

The operations of an SPV are limited to the acquisition and financing of specific assets. This separate company structure helps isolate the risks of these activities. SPVs can serve as counterparties for swaps and other credit-sensitive derivative instruments.

SPVs are formed as limited partnerships, trusts, corporations, or limited liability companies (LLCs). They can be designed for independent ownership, management, and funding. SPVs help companies securitise assets, create joint ventures, isolate corporate assets, and facilitate other financial transactions.

SPVs are commonly used in venture capitalism, where a group of investors pool their assets to launch a new business or invest in a startup. SPVs typically make a single investment into a business, in contrast to an investment fund, which makes multiple investments over time.

The financials of an SPV are recorded on its own balance sheet, separate from the parent company's. This separation allows SPVs to mask crucial information from investors, as seen in the Enron scandal, where SPVs were used to hide financial losses. Therefore, investors must carefully analyse both the parent company's and the SPV's balance sheets before making investment decisions.

SPVs have various legitimate uses, including asset securitisation, joint ventures, and property deals. They also play a role in public-private partnerships, where they help private companies manage financial exposure in capital-intensive projects.

SPVs provide benefits such as legal and financial protection for the parent company, direct ownership of specific assets, and tax savings. However, there are also risks and challenges associated with SPVs, including limited access to capital, complex launch processes in certain jurisdictions, and negative perceptions regarding tax evasion or unlawful activity.

Know the risks of investing in SPVs

Special Purpose Vehicles (SPVs) are separate legal entities and subsidiary companies created by a parent organisation. They are created for a specific purpose and have their own assets and liabilities, separate from the parent company. SPVs are often used to isolate financial risk, but they have also been used in the past to hide financial losses, as was the case with Enron in 2001.

Lack of Diversification

SPVs typically invest in a single company, which means there is a higher chance of losing your investment if that company fails. To mitigate this risk, investors can diversify by investing in multiple SPVs.

No Voting Rights

SPVs are the official shareholders of the company they invest in, so the investors in the SPV do not have voting or information rights. This means that investors must trust the fund manager to represent their interests.

Preferential Treatment

SPVs provide access to deal flow, but this may not be shared equally among investors. Fund managers may only open up certain SPVs to a select group of investors they know and trust, so new investors may not have access to all deals.

Fees

Investments in SPVs may be subject to carry and management fees, which can eat into returns.

Misuse of Funds and Misrepresentation

SPVs have been misused in the past to alter company financials and misrepresent financial health, as was the case with Enron. It is crucial to analyse the financials of the SPV and the parent company before investing.

Learn how SPVs work in venture capital

Special Purpose Vehicles (SPVs) are separate legal entities created by a parent company for a specific purpose. They are also referred to as Special Purpose Entities (SPEs). SPVs are often used in venture capital to pool money from a group of investors to make a single investment in a startup. This allows investors to gain exposure to a specific investment opportunity at a relatively low cost.

In venture capital, SPVs are typically formed as limited partnerships or limited liability companies (LLCs). The benefit of these business structures is that they can "pass through" income to their members, allowing them to recognise any business profits or losses on their personal tax returns. When an investor puts money into an SPV, they become a "member" of the SPV and receive "membership interest" in proportion to their investment.

SPVs are subject to regulations that limit the number of investors that can participate. In the US, SPVs raising $10 million or less can have up to 250 accredited investors, while those raising over $10 million are limited to 100 investors.

It's important to note that SPVs in venture capital carry more risk than other types of venture investments. Since SPVs usually invest in just one company, the chances of losing the investment are higher. Additionally, members of an SPV may not have the same voting rights or influence on the company's direction as they would as individual investors.

SPVs offer benefits to both investors and founders. Investors can pool their capital to access larger investment opportunities, while founders can accept capital from multiple investors without adding each one individually to their cap table, reducing administrative burden and keeping sensitive information within a smaller group.

Understand the benefits of SPVs for LPs

Special Purpose Vehicles (SPVs) are separate legal entities created for a specific investment purpose. They are designed for financial projects that require focused investment and are often used by venture capitalists to consolidate a pool of capital to invest in a startup. SPVs are beneficial to LPs in several ways:

Access to Specific Investment Opportunities

SPVs allow LPs to gain exposure to specific investment opportunities that may not be available to them otherwise. LPs can invest in a single company through an SPV, rather than having to invest in a portfolio of companies. This provides LPs with the flexibility to choose companies they are interested in investing in.

Lower Investment Costs

By pooling their money with other investors in an SPV, LPs can access investment opportunities at a relatively low cost. SPVs can have a large number of investors, allowing individuals to invest smaller amounts of money while still getting direct exposure to the company.

Networking Opportunities

SPVs provide LPs with networking opportunities, as they can connect with other investors and the GP managing the SPV. This helps LPs build relationships and gain access to future investment opportunities.

Streamlined Fundraising

SPVs often have lower minimum investment requirements compared to traditional investment avenues, making it easier to raise capital and broadening the pool of potential investors.

Maximized Impact of Capital

By concentrating funds on a specific venture, SPVs ensure that every dollar invested has a more significant impact, potentially leading to higher returns and a greater level of involvement in the project.

Simplified Cap Table

SPVs simplify the cap table of the target company, reducing the time and cost associated with managing it.

While SPVs offer these benefits to LPs, it is important to consider the risks involved, such as lack of diversification, no voting rights, potential for preferential treatment, and additional fees.

Know the pros and cons of SPVs vs. traditional VC funds

Special Purpose Vehicles (SPVs) are separate legal entities created by a parent company for a specific purpose. They are often used by venture capitalists to consolidate a pool of capital to invest in a startup. SPVs typically make just one investment into a business, whereas a traditional VC fund would make multiple investments over time.

Pros of SPVs vs. Traditional VC Funds

SPVs offer several benefits over traditional VC funds. Here are some key pros:

• Access and Cost: SPVs allow investors to pool their money and invest in a single company, providing access to investment opportunities with a relatively low cost of entry.
• Targeted Investment: SPVs enable investors to target specific companies they wish to invest in, rather than diversifying their investments across multiple companies in a portfolio.
• Flexibility: SPVs can be structured in various ways, such as limited partnerships or limited liability companies (LLCs), to suit different business objectives.
• Risk Isolation: SPVs are separate legal entities, so their financial risks do not carry over to the parent company. This isolation protects the parent company in the event of bankruptcy or insolvency.
• Simplicity for Founders: SPVs simplify the cap table management for founders by allowing them to accept capital from a group of investors without adding each one individually to their cap table.
• Faster Returns: SPVs are designed to provide faster returns to investors since they depend on the performance of a single company. The more successful that company is, the greater the ROI for SPV investors.

Cons of SPVs vs. Traditional VC Funds

However, there are also some drawbacks to consider when comparing SPVs to traditional VC funds:

• Lack of Diversification: SPVs invest in a single company, so if that company fails, investors may not see any return on their capital.
• No Voting Rights: Investors in SPVs typically do not have voting or information rights, as the SPV is treated as the sole shareholder.
• Fees: Investments in SPVs may be subject to additional fees, such as carry and management fees, which can impact the overall returns for investors.
• Adverse Selection: LPs in SPVs may encounter situations where they are offered investment opportunities that the VC is not pursuing, raising suspicions about negative signalling or adverse selection.
• Incentive Misalignments: The structure of SPVs can create incentive misalignments between VCs and LPs, especially regarding fees. VCs may collect carried interest on a per-SPV basis, potentially prioritising SPV returns over the core fund's performance.

Frequently asked questions