If you are looking to incorporate a business, you likely have sifted through tons of legal jargon. Corporations, LLCs, partnerships, sole proprietors, the list goes on. Here’s another one: Special Purpose Vehicles.
People typically associate Special Purpose Vehicles, or “SPVs”, with major corporations; however, they can be useful for businesses of all sizes. Companies can use SPVs to:
- Obtain secured financing;
- Engage in projects or joint ventures; and,
- Reduce liability risk.
We dive into what’s so special about Special Purpose Vehicles, and how they work.
What Is a Special Purpose Vehicle?
A Special Purpose Vehicle, or “SPV”, is a separate LLC established by a parent company to complete a unique business activity or task.
Most companies include broad purpose clauses in their corporate bylaws. These clauses basically say the company can undertake any action as long as it is authorized by law. In contrast, a company forming a Special Purpose Vehicle often binds the SPV to a limited purpose clause. This restricts the company’s actions to simply owning a particular piece of property or conducting certain business.
SPVs have many uses, however, the motivation for creating SPVs is generally to isolate the parent company from financial or investment risk.
Companies form SPVs as separate legal entities. In the subsidiary context, a parent company wholly owns the SPV. The parent company would be free from the liabilities and obligations of its SPV. If the SPV goes bankrupt, the other assets of the parent company typically remain isolated from the SPV liability.
Certain types of SPV’s also work “in-reverse”. These SPVs are “bankruptcy remote” entities (BREs). For those BREs, the Operating Agreement will say if the single member of the LLC goes bankrupt, an outside member will take over control of management and nominal ownership of the BRE.
The organizational documents of SPVs often restrict amending the purpose clause without consent from the company’s lenders. Lenders benefit from these restrictions by knowing the company will not use junk loans to engage in non approved activities or investments.
Why Companies Use Special Purpose Vehicles.
Companies across various industries use Special Purpose Vehicles to undertake specific business activities. These activities often include completing significant financial transactions, such as:
- Financing mergers or acquisitions;
- Financing large real estate purchases or development;
- Engaging in joint ventures;
- Isolating company assets or debt; and,
- Financing equipment purchases.
Corporations use Special Purpose Vehicles as a means of indirect financing through securitized loans. Here’s how this is done. A company can transfer assets from its own balance sheet to its Special Purpose Vehicle. The SPV can group these assets to limit the collateral and potential recourse available to a lender.
The parent company shields particular assets from its own debt obligations by having an SPV hold the particular assets on its separate balance sheet. This ultimately reduces credit risk for the parent company’s investors.
Companies also use SPVs for purposes other than corporate financing. For example, a company can use an SPV to protect its intellectual property. By owning intellectual property through an SPV, the company can keep valuable IP from leaking to competitors through any pre-existing licensing deals.
Is a Special Purpose Vehicle An LLC?
Companies often form Special Purpose Vehicles as Limited Liability Companies, or LLCs. This is because LLCs are easy to create and do not come with the bureaucracy or regulation associated with Corporations.
As an LLC, a Special Purpose Vehicle can have its own assets, liabilities and obligations separate from its parent company. In addition, ownership in the SPV can be easily transferred by amending the LLC Operating Agreement.
Special Purpose Vehicle vs. Subsidiary Company.
“Special Purpose Vehicles” and “subsidiary companies” are related terms describing similar concepts. Both terms refer to entities created by a parent company that have a distinct business purpose.
“Subsidiary” often refers to an operational business that either supports or is separate from the parent company. For example, Youtube is a subsidiary company formed as an LLC and is owned by Alphabet, Inc. (Google’s holding company).
“Special Purpose Vehicles” often do not hold operational businesses. They are typically just used as financing instruments or to hold certain company assets.
Benefits of Special Purpose Vehicles.
Special Purpose Vehicles can provide private companies with easier access to capital markets. Since the SPV is a separate entity, its risk profile is not identical to its parent company. If the SPV has cash flow and strong collateral, investors may be more inclined to purchase corporate bonds from the SPV instead of the parent company.
In addition, SPVs can also help companies obtain capital by accessing better borrowing rates.
Can Small Businesses Use Special Purpose Vehicles?
Businesses of all sizes can find ways to use Special Purpose Vehicles to reduce liability risk.
For example, a company can use a Special Purpose Vehicle for constructing a new office building. Companies can create separate entities for the purpose of obtaining financing for the project, acquiring the building permits, and engaging contractors.
By undertaking projects through Special Purpose Vehicles, business owners can protect company assets from the liabilities associated with a build.