While companies departmentalize their functions or divisions, a distinct and separate entity wholly dedicated to a specific project or purpose can create the necessary space to ensure its success and channel resources to facilitate this objective. This entity is called a Special Purpose Vehicle or SPV.
What is an SPV?
A special purpose vehicle, also known as a Special Purpose Entity or SPE, is a temporary entity created by a company for the sole purpose of financing a specific project. The funds for a particular project are routed through the SPV. The company that creates an SPV is called a parent company.
The key feature of an SPV is that its legal and financial status is independent of its parent company. This means that an SPV has its own financial statements, investors, assets, operations, and legalities. Although it is under the wings of the parent company for all practical or operational purposes, it is treated differently in the books of accounts as well as in the eyes of the law. This arrangement has several advantages.
Advantages of SPVs
The benefits that SPVs bring to the table make them viable for investors interested in specific projects and do not want to be involved in the risk or operations of the parent company. More investors mean more growth opportunities. SPVs are beneficial in more than one way, as discussed below.
1. Specific Purpose
The SPV gives clarity to investors and other stakeholders regarding the utilization of funds that are poured into it. An investor knows the exact purpose for which their money is being used, which is not possible when they invest in a company. This clarity gives them more reason to invest in an SPV vis-à-vis a company. This is a plus point for companies considering an SPV since potential investors can be roped in more easily due to the specificity of the objective and operations.
2. More Financing Options
Since the SPV is an entity that is separate from its parent, its credit rating can also be higher, opening up the possibilities of better debt financing opportunities at a lower price. SPVs can work in favor of highly leveraged companies since their ability to take a loan is unaffected by the outstanding amounts that their parent owes to banks or other lenders. A company can create more financial legroom by commencing an SPV.
3. Easier Equity Management
The equity of an SPV is distinct from that of its parent company. The SPV can issue stocks and have a cap table independent of the parent company’s cap table. This makes equity management easier and also less confusing for users of this information to understand the ownership and purpose of the company and the SPV as separate entities, which enables better decision-making.
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4. Easier Fundraising
One of the top concerns of any startup at the initial stages is fundraising. With the number of startups on the rise and the global pandemic, obtaining funding is difficult. SPVs make it easier to raise funds. This is because of two reasons:
- The amount of investment is lower in an SPV compared to a Venture Capital investment, which increases the pool of potential investors
- SPVs are cheaper; they charge a lower management fee as compared to VCs, making SPVs preferable
Startups easily create an SPV which raises funds for the specified business of the startup, instead of waiting for venture capitalists who like the idea of the investors.
4. Other Advantages
In addition to the above points, SPVs have other advantages too. They make it easier to trace the movement of funds for a designated purpose. They can also do the necessary work for the project to become successful without diluting the focus. Finally, SPVs also protect the parent company against the risk of failure without causing a disturbance to its mainstream operations.
How does an SPV work?
An SPV is a separate legal entity and is treated as an artificial judicial person independent of its parent company. Accordingly, it falls under the ambit of the Companies Act, 2013. The major difference is that its Memorandum of Association limits the SPV’s activities to the specified project, narrowing the scope for business. This is done to protect the interest of the investors.
Steps involved in the creation of an SPV:
- The company creates a separate entity (the SPV) and becomes the parent company.
- The SPV issues securities to investors.
- The proceeds from the issue of securities generate cash or liquid funds.
- These funds are used to purchase assets from the parent company. These assets are required for the functioning of the SPV.
- The assets are transferred in exchange for funds and are utilized by the SPV for its dedicated purpose.
To Sum Up
An SPV is a distinct entity created by a company for a specific purpose. The isolation of financial risk and the legal distance between the SPV and its parent company makes them viable for companies looking to explore a particular project while protecting themselves.
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