If you have any memory of 2001, you remember the scandal involving the company Enron hiding a gargantuan amount of debt from the public. Once the details started to emerge, prison sentences and enormous fines gave some semblance of justice, but the question remained: how was this possible? The answer lies in SPVs (or Special Purpose Vehicles). They are a sort of bankruptcy-remote entity that protects a parent company from losses and damages. However, without strict regulation, they can be severely taken advantage of. This all begs the question: are SPVs safe to invest in today? First, let’s take a look at specifically what an SPV is…
What is an SPV?
SPV stands for Special Purpose Vehicle/Entity. It is a subsidiary company that has an asset and liability structure, as well as a legal status that keeps its obligations secure, even if the parent company it is invested in goes bankrupt. An SPV is also a subsidiary corporation that is designed to serve as a counterparty for swaps, as well as other credit-sensitive derivative instruments. SPVs are primarily used to reduce and isolate financial risk.
An SPV can be formed through limited partnerships, trusts, corporations, limited liability corporations or other entities. An SPV has a lot of different possible functionalities. It can be:
- …designed for independent ownership, management and funding of a company
- …for creating a synthetic lease that is expensed on the company’s income statement rather than recorded as a liability on the balance sheet
- …as protection of a project from operational or insolvency issues
- …helpful for companies securitize assets, create joint ventures, and isolate corporate assets.
For more information about what an SPV is, you can check out this informative article here.
As you can imagine, the world of SPVs can be complex. And, like with any complex topic involving money, there are a series of pros and cons that should be considered before you start investing in a fund that goes through an SPV.
1. First Steps of an Investment Strategy: The initial benefits of using a special purpose vehicle is that an SPV can be a great initial step into a broader investment strategy for LPs (limited partners). The reason for this is that an SPV gives LP investors enough financial leverage to get pro-rata rights, which give investors the right to be involved in further rounds of funding so that they can continue to own the same percentage of a company.
2. Gain Access to Other Deals: Using an SPV allows for investors that want to gain access into specific industries to get their foot in the door and participate in deals that they wouldn’t otherwise be able to negotiate into. In this way, some investors use SPVs to start investing in different sectors of the market to diversify their portfolios for future growth.
3. Quickly Invest in Growing Companies: Because an SPV is able to buy up more shares in venture capital projects at a faster rate than each individual investor would otherwise be able to purchase, it enables LP investors to quickly invest more into companies that are growing quickly. If the general partner (GP) is operating the fund efficiently, then startups that are achieving rapid growth will be allocated more funds to allow for outsize returns for all investors.
1. Selective GP Deals: One of the most major advantages for LP investors that is gained by investing through an SPV is the ability to gain pro-rata rights through quickly growing startups. However, if an SPV is operated by a highly selective GP, then there might be situations where some LPs are offered pro-rata rights, while others are not. This leads to confusion over what purpose the SPV will have for each individual investor.
2. Relying too heavily on venture capitalist: An LP investor is putting their complete faith in a venture capitalist (VC) to invest their capital into projects and companies that show true promise. If LPs are given pro-rata rights to companies that aren’t being aggressively pursued by other SPVs, then it begs the question of if the VC is overlooking potential negatives. This reliance on a VC can make some investors uncomfortable.