- What is Special Purpose Vehicle?
As the name suggests, Special Purpose Vehicle (“SPV”) is an entity incorporated with a particular narrow purpose and works with that purpose only.
SPV is a separate legal entity created by an organization. The SPV is a distinct company with its own assets and liabilities and its own legal status. Usually, they are created for a specific objective, often to isolate financial risk. As it is a separate legal entity, the special purpose vehicle can carry on if the parent company goes bankrupt.
- How does investing in an SPV work?
The concept of SPV is not new, and however, its gaining popularity in the start-up eco-system because of its favourable structure for angel investor participation. SPV is also known as the Special Purpose Entity (“SPE”) of Syndicate in the start-up eco-system.
In most cases, when you invest in an SPV, you put your money into an entity designed to make a single investment. Once funds are collected, they are invested in a start-up, and the SPV becomes an investor. Individual ownership on the company capitalization table (cap table) is reflected through the right in the SPV as an investor.
- What are the entity types for SPV?
The originator has flexibility in choosing an appropriate legal structure for SPV based on its requirement. SPV can be in the form of a company, trust, society, a firm, LLP etc. An SPV can be in all possible forms of a business entity capable of being formed.
The provisions of parent law for the incorporation of such entity, i.e., the Companies Act, Trust Act, the Partnership Act, etc, will apply to the formation of such SPVs.
- Why is SPV used?
The SPV structure provides flexibility. The primary purpose of an SPV is to make start-up investing accessible and affordable to ordinary accredited investors.
SPVs offer attainable entry points, giving access to most accredited investors. For example, an SPV accepts a little $5000. It means that you can build a diversified portfolio of 20 start-ups with as little as $100,000. And if you want to keep start-up investments at 5% of your net worth, this means you now only need a net worth of $2M (versus the $10M net worth needed when investing directly).
- The disadvantage of an SPV?
There are many costs involved in setting up an SPV, like the cost of incorporation, cost of registration, and stamp duty at the time of company transfer. Incorporation of SPV as a Company will require continuous fulfilment of compliances.
There is a significant risk on the carry. When you invest through an SPV, you are all in. The SPV makes a single investment into one company, and if that company fails, you stand to lose everything, including the fees you pay in. You may pay more in fees in a VC fund, but your portfolio becomes more diversified over time, usually with some wins and some losses. One way to mitigate this situation is to have a portfolio approach to your angel investments. Try to invest in a portfolio of 15-20 start-ups. Another way to reduce the risk of losses is to diversify your start-up investments across different start-ups, stages and sectors.
- Difference between SPV and Venture Capital (VC)?
SPV typically only invests in a single start-up. Therefore, as an investor, you know where your dollars are invested in advance. On the other hand, a VC Fund collects a large pool of capital then allocates it to a portfolio of start-ups over time. As an investor in a VC Fund, you will not know how your dollars are being invested in advance.
VC funds are convenient for a wealthy investor who does not have the time to source or evaluate each investment opportunity individually. In contrast, SPV is ideal for small investors, and SPVs are suitable mechanisms for new angel investors to get started.
- Incorporation process of SPV in India?
Incorporation of SPV will occur in the respective law of the chosen type of entity. For example, suppose it’s an LLP. In that case, the registration will occur under the Limited Liability Partnership Act 2008, and if it’s a company, then the incorporation will take place under the Indian Companies Act, 2013.
The only requirement is that the constitution document should have a limited objective of the entity. SPV Incorporation generally takes 15 days, subject to the availability of all required documents.
Hope this article helped to understand the concept.
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