Knowledge Base: Understanding Special Purpose Vehicles (SPVs)

This Article includes:

• What is an SPV
• How do SPVs Work
• Advantages of using an SPV
• Disadvantages of SPVs
• Setting up an SPV can be pretty expensive
• Alternatives to SPVs
• FAQ's

What is an SPV?

A Special Purpose Vehicle (SPV) is a distinct legal entity created for a specific investment purpose. This entity allows investors to pool their funds to collectively invest in a company. In the context of investments, SPVs are often set up as limited liability companies (LLCs) or limited partnerships in the UK. The SPV itself owns the shares in the target company, while individual members of the SPV own a percentage of the SPV based on their investment.

How Do SPVs Work?

Investors put capital into the SPV and receive membership interests proportional to their investment. For example, if an investor contributes £25,000 to an SPV that raises £250,000, their membership interest is 10%. The SPV then appears as a single entry on the target company's cap table, which can simplify the investment process, hence why an SPV can be referred to as a Nominee or a Rollup, in some cases. It doesn’t make the actual transaction any more or less complicated, you still need an instrument between the company and the SPV, for example a priced round, agile round, ASA. The SPV then has its own investment agreement between the individual investors (beneficial owners). As FounderCatalyst manages voting and investor consents, the benefits to the company of an SPV is typically that it keeps the cap table clean. Some of the general advantages and disadvantages are considered below.

So, what are the advantages of using an SPV?

For Founders

• Simple CapTable: As an SPV acts as a single entity, this makes it easier for founders to manage their cap table.

• More Freedom: If a founder wishes to sell a share of their firm, dealing with a large number of individual investors might be tough. An SPV combines these investors into a single entity, streamlining the negotiating process and making it easier to sell shares.

• Preserve control: Managing several individual investors can complicate decision-making and strategy. With an SPV, the founder only works with one entity, making it easier to keep control over the company's direction.

For Investors

• Access to Larger Deals: By pooling funds, SPVs can participate in larger, potentially more lucrative deals that individual investors might not afford on their own.

• Defined Investment Choices: Investors in an SPV know precisely which company their funds are being invested in, offering more control compared to investing in a venture capital fund.

• Learning from Experienced Investors: New investors can benefit from the expertise of a lead investor managing the SPV.

• Limited Liability: As SPVs are often set up as limited liability companies, investors' risks are confined to their investment in the SPV, protecting them from broader liabilities.

Disadvantages of SPVs

For Founders

• Passive Investors: Investors grouped in an SPV might be less engaged or active in supporting the startup, as they are part of a collective investment rather than holding individual stakes. This can reduce the level of mentorship, networking, and additional support typically provided by individual angel investors.

• Investor Agreement: Ensuring all investors within the SPV agree on key decisions can be challenging, potentially leading to delays or complications in executing strategic initiatives. Any issues or disputes with investors will need to be mediated through the SPV's structure, potentially complicating conflict resolution.

• Setup and Maintenance Costs: Establishing an SPV involves legal and administrative expenses. These costs can include legal fees, accounting fees, and ongoing management costs, which may be significant for early-stage startups with limited budgets.

For Investors

• Limited Flexibility: Once invested, members must adhere to the SPV’s rules and cannot withdraw or reallocate their investment.

• Administrative Complexity: Setting up and managing an SPV requires significant administrative effort and compliance with legal obligations.

• Single Investment Focus: SPVs invest in only one company, meaning the failure of that company results in the loss of the entire investment.

• Potential Lack of Voting Rights: Individual investors typically do not have direct voting rights in the target company, as the SPV manager votes on behalf of all members.

Setting up an SPV can be pretty expensive...

For a founder setting up an SPV, these will be taxes, management and maintenance costs, and for an investor you’ll need to pay deal fees, subscription fees and much more. So, what are the alternatives?

Alternatives to SPVs

• Direct Investment: Investors can directly negotiate and invest in a startup, which provides more control but is more complex for the startup to manage multiple investors.

• Convertible Loans: These loans convert into equity at the next funding round or can be repaid with interest, offering protections and potential discounts on future shares.

• Equity Crowdfunding: Investors can use platforms to invest smaller amounts into multiple companies, with shares held by a nominee company, simplifying the process for both investors and startups.

FAQ's

With an SPV, can I keep my S/EIS benefits?

Yes, but only if the SPV is set up correctly. If your SPV was set up as an LLP or LP, HMRC would deem the shares to not be held by the investors, and therefore your S/EIS tax breaks would not be realised. However, when structured as a UK bare trust, the eligible shares are considered held by a nominee on behalf of the individual and thus the tax breaks will apply.

Do investors still get a vote through an SPV?

Yes, investors can still get a vote through an SPV, but it's typically exercised in a consolidated manner. When an SPV is used, all the individual investors' interests are pooled together, and the SPV votes as a single entity on their behalf. The voting rights of the investors within the SPV are usually determined by the terms of the SPV agreement. Investors may have a say in decisions, but their individual votes are combined into one collective vote that the SPV casts.

Does a clean cap table matter?

SPVs provide a structured and efficient way for investors to pool resources and invest in specific opportunities while offering clear benefits such as risk limitation, simplified cap tables, and enhanced financing opportunities. On the other hand, they also come with challenges like administrative complexity, limited investment flexibility; not to mention, they’re not cheap. For the majority of people, using our platform and adding your investors like normal is fine. To VC’s however, SPVs are the way forward.

Why does the VC want this?

VC’s prefer SPVs because they streamline the due diligence process by conducting Know Your Customer (KYC) and Anti-Money Laundering (AML) checks on behalf of all investors involved. When dealing with a large number of investors, an SPV significantly reduces the time and effort required for a VC to perform due diligence on each individual. Additionally, SPVs simplify decision-making processes, as they vote as a single entity on matters requiring investor consent, such as special resolutions, making it easier for VCs to manage investor relations. Platforms like Crowdcube and Seedrs, though not explicitly labelling them as SPVs, operate similarly by holding shares on behalf of investors, allowing businesses to interact with a single nominee team, which handles all investor management and ensures that the benefits of the investment, like tax relief and returns, are appropriately distributed to the underlying investors.

So how can we help?

We don't currently offer SPV / Nominee services (though watch this space) but some of our customers use our platform in conjunction with Odin where an SPV is a requirement. We have other customers that have 70+ shareholders directly on the platform and there is no problem with managing this, especially if the investors do not have investor consents and (ideally) non-voting shares.

Do I need to create individual share certificates for the all investors who invested under Nominees?

No, you do not need to create individual share certificates for these investors. When investments are made via a nominee, the nominee is the legal shareholder, not the individual investors. Therefore, the only share certificate required is for the nominee itself.

The Nominee has asked for individual share certificates. Can I create them at all?

Legally, this is not appropriate. Share certificates should only be issued to the actual shareholders of the company, and in this case, the shareholder is the SPV, not the individual investors.

Consider reaching out to clarify their request, as issuing individual certificates for non-shareholders would not be correct.

How can I create the Share Certificate for a Nominee?

To create the share certificate for Nominees, follow the standard process:

• Prepare the certificate
• Sign it and have it witnessed
• Send it to the nominee as the legal shareholder