Special Purpose Vehicle: Does Your Start-Up Need One?
What is a Special Purpose Vehicle (SPV)?
In Singapore, a Special Purpose Vehicle (SPV) is a legal entity created by a company or investors in order to fulfil specific or temporary objectives of the originating company or investors. It is also known as a ‘special purpose entity’.
Why Set Up a Special Purpose Vehicle?
Possible reasons for setting up an SPV include securitisation (where risks in underlying assets held by the SPV are reallocated to investors who are willing to bear such risks), placing assets under the ownership of the SPV for financial protection, and for investment.
When an SPV is used for investment purposes, investors typically pool their money together and invest in a start-up as a single entity through the SPV. This is done either by buying shares in the start-up or by extending a loan to the start-up in return for shares in it.
This means that the start-up raises funds for its business from the SPV as the start-up’s investor, and it is also the SPV that owns shares in the start-up. This arrangement differs from when individual investors each hold a certain number of shares in the start-up.
This article focuses on the advantages and disadvantages of using SPVs in order to raise funds for Singapore start-ups. Please refer to our other article to learn more about special purpose acquisition companies (SPACs).
What are the Benefits of Setting Up a Special Purpose Vehicle?
An SPV limits shareholder influence
An SPV allows for the injection of fresh capital while limiting the need for shareholder interaction, which would normally accompany each fresh injection of funds.
If a start-up founder were to raise funds by allowing individual investors to buy shares in the start-up, they would potentially need to deal with the concerns of every new shareholder over the running of the company, which could be time-consuming and even overwhelming.
An SPV would allow the start-up to liaise with only one investor (i.e., the SPV company) as opposed to dozens of investors. This can be crucial for start-up founders whose decision-making process involves technical expertise which ordinary investors may not possess (e.g., engineering or medical companies).
The managers of such companies would naturally wish to limit unnecessary influence from investors who are not sufficiently informed.
An SPV attracts investors due to the additional protection it provides
If the start-up company structures its SPV such that the SPV has its own assets which investors have access to, this will provide security for investors as they will still be able to recoup their investment.
Traditionally, investors of a company may not be able to recover assets of a company if the company becomes insolvent. This is because other stakeholders (e.g., employees, banks) may have a prior claim on the company’s assets.
However, if an SPV is set up and investors have contributed funds to the SPV, then the investors may be able to recover the value of the loan by making a claim against the SPV’s assets even if the start-up becomes insolvent. This affords additional protection for investors who may then be more incentivised to provide funding.
An SPV may attract more funding
Instead of sourcing for a deep-pocketed institutional investor to fund a start-up, an SPV allows for a larger group of smaller investors to raise funds for a start-up, potentially raising a sizeable amount of funds.
What are the Limitations of Setting Up a Special Purpose Vehicle?
Potential difficulty of building investor confidence and attracting investors
Potential investors in SPVs may perceive that they will be afforded less insight into the financial matters of the company as compared to the other shareholders of the company. This is because ordinarily, members of a start-up would be entitled to attend company meetings and vote on resolutions.
However, those who invest by way of an SPV may not be entitled to attend such meetings as they are not direct members of the start-up. Instead, the directors of the SPV may decide who can attend such meetings.
This comparative lack of insight may deplete investor confidence, possibly deterring some from making investments in the start-up.
Certain conditions may be attached to funds
If the SPV is run by sophisticated investors or investors with little appetite for risk, the investors are likely to attach stringent conditions to the funds they provide. For example, they may insist upon having a change of control clause in shareholders’ or loan agreements, as the success of a start-up is often closely linked to the start-up’s founders and initial equity holders.
A change of control clause is one which gives investors certain rights if there is a change in ownership or management of the other party to the agreement. For example, a change of control clause could state that investors have the right to sell their shares at a certain price or obtain accelerated repayment of loans if certain founding members were to leave the start-up.
This is especially relevant for companies which have been founded by visionary leaders (think the likes of Mark Zuckerberg of Facebook and Jeff Bezos of Amazon) who have contributed a great deal to the company.
Investors often come on board because of certain business personalities and may attach strict conditions to their funds in order to protect the value of their investment. This, in turn, may limit decision-making by start-up founders and management as they would be wary of triggering the conditions that would enable investors to sell their shares or demand accelerated repayment of loans.
Investors may not be willing to contribute to SPVs with little or no assets
If the SPV in question has few physical assets, it may be difficult for it to provide security or guarantees in exchange for funding. This is because investors will not be able to reliably seize and value such assets should they require repayment of a loan.
As a result, investors may be unlikely to contribute funds to the SPV without some form of insurance for their investments.
How to Set Up a Special Purpose Vehicle in Singapore
An SPV will usually be structured as a private company limited by shares or a Limited Liability Partnership (LLP).
An LLP is owned and run by at least 2 partners, while a private company can have a maximum of 50 members. A company with more than 50 members will have to be listed on the Singapore Exchange (SGX).
Apart from the existing requirements for incorporating a company or forming an LLP, there are no additional regulatory requirements to fulfil when setting up an SPV.
Is an SPV best registered as an LLP or a company?
Both the partners of an LLP and owners of a company are shielded from debts incurred by the business.
While registering a business as a company attracts more stringent compliance obligations, it is suggested that a company is a better vehicle for the SPV as it allows for easier transfer of ownership through the purchase of shares. This will help attract investors who wish to acquire and dispose of shares quickly.
Compliance Requirements for Special Purpose Vehicles in Singapore
If the SPV in question is an LLP, each partner will be taxed according to his personal income tax rate. If the partner is a company, it will have to pay corporate income tax on its share of the LLP’s income.
If the SPV is set up by a Singapore start-up that is listed on the SGX, the start-up will need to comply with the International Financial Reporting Standards and include the assets and liabilities of its SPV on the start-up’s own financial statements. This consolidation of financial statements is necessary if the start-up satisfies all of the following elements:
- It has power over the SPV
- It has exposure or rights to variable returns from its involvement with the SPV
- It is able to use its power over the SPV to affect its returns.
If the SPV is set up by a Singapore start-up considered to be a ‘small entity’, the start-up will need to comply with paragraph 9.11 of the Singapore Financial Reporting Standard (SFRS) for Small Entities and prepare consolidated financial statements that include information on the SPVs it controls.
According to paragraphs 1.2 and 1.3 of the SFRS for Small Entities, ‘small entities’ are defined as entities which are not public charities or public companies. They do not trade debt or equity instruments in a public market.
Furthermore, they publish general purpose financial documents and meet at least 2 of the following 3 criteria:
- Total annual revenue of not more than S$10 million
- Total assets of not more than S$10 million
- Total number of employees of not more than 50.
For the purposes of preparing the consolidated financial statements, factors which indicate that an entity controls an SPV include the following:
- The SPV’s activities are conducted on behalf of the entity
- The entity has ultimate decision-making powers over the SPV’s activities even if the SPV’s daily tasks have been delegated
- The entity is able to obtain the majority of the SPV’s benefits and may be exposed to risks related to the SPV
- The entity retains the majority of the risks related to the SPV or its assets
If you require assistance with setting up and structuring an SPV to raise funds for your start-up in Singapore, do get in touch with a professional corporate services firm.
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