A couple of years ago I was meeting a friend of mine over lunch. At the time, he worked in the Alternative Investment Group of a large bank in Investment Banking. While discussing investment opportunities in the market he mentioned that it’s kind of sad that some of the most lucrative opportunities out there aren’t available to a broader public.
He and his team administered and marketed SPVs (Special Purpose Vehicles) for already established companies which wanted to raise additional money. While explaining to me how this class of structures could address all kind of investors like family offices, individual investors or professional institutional investors, I was wondering why Special Purpose Vehicles were still a niche market, especially regarding the fact that banks were using them for a long time.
As a matter of fact why should the threshold for a minimum investment be $250k in the example of an individual who wants to invest into an SPV with a bank? At least since the IPO of Twitter and its S-1 filling and a large growth round of Pinterest a broader public knows that several startups did use SPVs to cover their financing needs.
Advantages of Special Purpose Vehicles for Startups
Looking at the underlying structure of SPVs they seem to be a perfect fit for a startup seeking funding for its operations which is something done at Onevest for the startups raising capital. The typical minimum investment for an angel investor is $25k or even more. The minimum investment into an SPV can be much lower, which opens a whole new investor base.
Furthermore, all investors are pooled in one single entity which can make life for a young startup company a lot easier. Management only needs to deal with one single point of contact, instead of chasing dozens of people down for signatures. In this case, it’s usually the lead VC who organizes the SPV or the service provider of the platform. This is a huge advantage especially if seeking financing on startup investing platforms where there could be a ton of people participating in the offering. On the one hand, a startup can meet its funding minimum by gathering smaller sums from more individuals and on the other hand it doesn’t have to deal with all of them. Normally these SPVs can fit up to 99 people.
From experience, several professional investors know that the “smaller” the investors the more risk-averse they tend to be. At first glance, this seems like something good because it means that if those kinds of investors are willing to put money to work with you, they truly believe that the idea behind the company is solid. However risk-averse investors and especially a person who puts his private savings to work has a lot faster second thoughts regarding an investment and tends to have doubts about the uncertain future of entrepreneurship. This is a clear contrast to an Angel or VC who has experience in startup funding and can bear a potential underperformance of an investment (even though they usually don’t appreciate that). Here lies a clear advantage of an SPV.
The management doesn’t have to worry about individual investors. It only has to deal with the lead VC or the person managing the SPV. As a young and dedicated startup company, it’s much easier with a single point of contact who has a feeling for the market he’s in and who gives you time and space to envision your ideas.
Hence, an SPV can provide an easier access to funding while at the same time retaining the benefits of other funding-models by providing the guidance and mentoring a VC or Angel offers.
In addition to that, an SPV may not only provide funding, but can also represent a new strategy with regard to tax savings, business and brand management. These benefits arise from the underlying structure of an SPV because it represents a separate legal entity.
An alternative approach to SPVs
SPVs can house specific assets or liabilities. Looking back to the origins of this structures they were initially build to outsource liabilities in the form of debt from a parent company in order to eliminate it from the balance sheet. However, an SPV isn’t limited to owning the debt but can also house trademarks, brands, copyrights or patents. And this is where it gets interesting for a startup. Transferring intellectual property to an SPV implies several key benefits which are capital financing, tax savings, and better business management.
Banks use SPVs usually for securitisation. A startup company can basically do the same by transferring, for example, a patent or a brand into it and raise funding which is secured by the royalty income the brand receives. The company transferring the brand would forgo the royalty payments from the brand until the ownership reverts back to it after the initial amount of capital raised is paid back. In this case, the brand would serve as collateral which could, for example, lead to a decrease in the rate charged for a loan. Alternatively the special purpose vehicle can still be used to seek funding from other private investors. The main difference between the earlier examples is that securitisation means you take a loan and don’t offer a capital stake in the company. Transferring intellectual property into the SPV lowers the interest rate charged substantially while retaining at the same time a company's ownership of the intangible assets. The proceeds from the securitisation in turn can be invested in the parent company.
With regard to business management, it can be beneficial to transfer intellectual property. The cash-flows generated by intellectual property, license agreements or copyrights, would be in one entity, which makes it much easier to manage them. The healthcare industry serves as a good example where an SPV can streamline operations. Healthcare companies usually hold a vast amount of patents and all income is derived from products using these patents. The products are sold internationally to multiple partners, business units, distributors, and agents. Placing the patents into an SPV centralizes the cash-flows from licensing to a single entity and would reduce administrative expenditures.
Finally, SPVs can be registered in low-tax jurisdictions like the Bahamas or the Cayman Islands. This reduces the tax burden significantly which in turn frees up more cash for investing into business operations.
Why should startups use an SPV?
In a low-interest-rate environment fuelled by central banks around the world and several rounds of quantitative easing which lifted stock markets to record highs this presents a much welcomed and needed shift in how we approach investing.
In a world starving for yield, startups can form a new backbone for adequate returns while at the same time generating employment. Thus lowering the entry barrier is mutually beneficial for both the investor and the startup company. It means more startups can get funding while at the same time a larger number of investors can profit from the developments in the startup scene.
Regarding the underlying business of a startup it can be also beneficial for a couple of reasons mentioned earlier. Any industry that accumulates intellectual property is a potential candidate for management and securitisation through SPVs.
The possibility to transfer intangible assets into an SPV introduces new strategic tools to the management and should be considered as an additional opportunity for a startup to enhance growth.
***You should consult with your lawyer or financial advisors before using SPVs.***
Alejandro Cremades is the Co-Founder & Executive Chairman at Onevest, a leading startup investing platform connecting early stage startups with accredited investors. Onevest also matches entrepreneurs with core founding team members possessing complementary skills and shared goals and values, scientifically creating balanced teams.
Follow Alejandro on Twitter @acremades