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A Special Purpose Vehicle (SPV) is a company created to isolate financial risk.
SPVs are typically used for:
- specific projects to invest in or
- to hold a set of assets and liabilities.
Let's take a look at each use case separately.
SPV for a specific project to invest
When an SPV is established for a particular project, it gathers funds from various investors, and all of these pooled resources are directed into a single specific company. A group of investors puts money into an SPV, then the SPV invests in a target company.
The primary distinction between an SPV and a traditional venture fund is that an SPV focuses all its investment on a single company. In contrast, traditional venture capital (VC) funds diversify their investments across multiple companies that align with the fund's investment strategy and target industries.
Another key difference is that traditional VC funds are designed for long-term investments, often taking up to 10 years to exit all investments in a fund’s portfolio. On the other hand, SPVs aim to return money to investors more quickly, as the return depends on a single company reaching an exit, such as through an acquisition or an IPO.
LLC SPV or LP SPV
A Limited Liability Company (LLC) SPVs or a Limited Partnership (LP) SPVs are commonly utilised in Europe because it can be set up quickly and easily in many European countries. In countries like Estonia, Latvia, and Lithuania, process of setting up LLC SPVs and LP SPVs can be completed entirely online.
Additionally, in Estonia, non-residents can establish an LLC SPV and LP SPV electronically if a specific criteria through e-Residency programs are met.
However, the rules governing SPVs differ depending on the law in the country where the SPV is incorporated, therefore, one should always consult lawyer on any possible limitations each country may have, for example, in total number of members or investment amounts of that SPV.
Who owns the shares in an SPV investment?
The SPV holds the shares acquired in the target company since it acts as the investor in that company.
The individual members of the SPV are actually investors in the SPV itself. They do not directly own the shares. Instead, they receive a portion of any profits generated by the SPV.
How do SPVs work?
Investors contribute funds to the SPV and become its members, each holding a membership interest, which represents their share of the total investment in the SPV.
For instance, if an investor X contributes €10’000 to an SPV that raises a total of €1'000’000, investor X membership interest would be 1%.
Once the SPV has raised the necessary funds, it makes a single investment in a target company. On the company's cap table, the SPV is listed as a single entry.
SPVs are often referred to as pass-through vehicles because the SPV's income is distributed to its members.
For example, if the SPV invests in a company that is later acquired, resulting in a €100'000'000 gain for the SPV, a member with a 1% membership interest would receive 1% of the income, amounting to €1’000'000, minus any applicable carry fees.
Why use an SPV?
For startup founders, SPVs offer a simple way to onboard multiple investors through a single entry on the cap table – SPV.
For investors, SPVs are a popular and easy-to-setup alternative to VC funds, allowing them to pool resources and invest in a specific startup quickly and efficiently.
SPV to hold a set of assets and liabilities
One notable use of SPVs is to hold a specific set of assets and liabilities, providing a clear and organised structure. Very often used to pool employee stock options under one SPV, this structure involves creating a SPV, typically a limited liability company (LLC), in which ESOP participants hold shares.
How It Works?
- Formation of the Employee SPV: An employee SPV is created as a separate business entity. This company holds two types of shares:
- ESOP Participant Shares: Held by employees participating in the ESOP.
- Founder Shares: Held by the founders or some of them.
- Control and Management: Founders (or some of them) must participate in the employee SPV to exercise control and management functions, ensuring the alignment of interests and effective governance.
- Stake in the Startup: The employee SPV holds a direct stake in the startup equal to the ESOP Pool. This pool is then distributed among the ESOP participants within the employee SPV.
Example
Imagine a startup, TechInnovate, wants to set up an employee SPV to manage its ESOP. Here's how it could look:
- TechInnovate LLC forms an employee SPV, called TechInnovate Employee SPV, LLC.
- Shares Allocation:
- Employees: 40% of the shares in the TechInnovate Employee SPV, LLC are allocated to ESOP participants.
- Founders: 60% of the shares in the TechInnovate Employee SPV, LLC are held by the founders.
- ESOP Pool Distribution:
- The TechInnovate Employee SPV, LLC holds a 10% stake in TechInnovate LLC.
- The 10% stake is distributed among the ESOP participants within the TechInnovate Employee SPV, LLC proportionally based on their shares.
Why use an SPV?
- Clarity: By consolidating employee shares into a single SPV, the company's cap table remains simpler and cleaner. This avoids the clutter of having numerous individual entries for each employee shareholder.
- Centralized Management: Founders or key executives can maintain better oversight and control over the ESOP through the SPV. This centralized control helps in making strategic decisions related to employee shares.
- Isolation of Liabilities: The SPV structure can isolate liabilities associated with employee shares from the parent company. This legal separation can provide an additional layer of protection for the company's core assets.
- Simplified Due Diligence: Investors often prefer a clean and straightforward cap table. An SPV makes due diligence easier and more attractive for potential investors or acquirers by consolidating employee equity.
Whether you’re aiming to invest in a single project or streamline your company’s assets and liabilities, SPVs offer a focused, efficient, and often quicker way to see returns. They keep cap tables clean, simplify management, and provide a neat solution for holding and managing financial interests.
In a nutshell, SPVs are the unsung heroes of the investment world – versatile, efficient, and incredibly useful for both startups and investors. So, whether you’re looking to make a targeted investment or streamline your company’s financial structure, an SPV might just be your new best friend.
