By Andrew Stephenson
An SPV -- which stands for Special Purpose Vehicle -- is a legal entity that is organized and operated for a specific purpose. In the context of Regulation Crowdfunding (Reg CF), an SPV’s sole purpose is to organize the investors from a crowdfunding raise into one entity and make the investment into the issuer (meaning the startup or company) that created the SPV.
As an investment vehicle, SPVs have been in use for years outside of Reg CF. In March 2021, they became an option within Reg CF when new rules from the Securities and Exchange Commission (SEC) took effect creating this special class of SPVs that must meet the definition of a “crowdfunding vehicle.”
👉 The main benefit of raising capital through an SPV for a company is that it reduces the number of investors listed on the company’s capitalization table (cap table) in order to avoid triggering the Exchange Act’s reporting requirements, which can be time and cost prohibitive for a startup.
For companies, there may be a secondary benefit if they plan to raise money in the future from institutional investors. Those investors will request a copy of your cap table during due diligence, and there’s a perception that lengthy cap tables are less appealing to institutional investors and venture capitalists. Consolidating your crowdfunding investors on one line through an SPV enables you to overcome this perception.
👉 For an investor, if the SPV is structured correctly, there should be no difference between investing in a Reg CF campaign through an SPV or directly into the company. The economics should be the same for the investor, except taxes on an exit event may differ slightly (more on this below).
Let’s dive deeper into SPVs for Reg CF campaigns
According to Section 12(g) of the Exchange Act, any company with more than 500 nonaccredited investors and more than $10 million in assets must report financial information as if it were a publicly reporting company. Those quarterly and annual reports are time intensive and can require costly audits and other accounting services, which would strain a startup.
Since a successful crowdfunding campaign can draw 500 or more nonaccredited investors, some companies choose to operate their crowdfunding campaign through an SPV that pools investors from the campaign so they can be listed as a group on one line on the cap table. For reporting purposes only, everyone in this round then counts as one investor, insulating the startup from triggering the Exchange Act’s reporting requirements.
Prior to the availability of SPVs for Reg CF offerings, companies could only rely on the conditional exemption from becoming an Exchange Act reporting company by being current in its ongoing reports, engaging a registered transfer agent, and having assets of less than $25 million. Once the company exceeds the asset threshold, it has a two year transition period to becoming an Exchange Act reporting company.
What does an SPV do?
The SPV is created by the company raising funds, and the only business the SPV conducts is:
- Administering the shares issued during the crowdfunding raise
- Maintaining records of shareholders from this round
- Investing the amount raised into the company that created the SPV
- Issuing annual reports about the company and SPV to investors
- Soliciting votes from shareholders if voting rights were granted in the offering terms
- Voting on behalf of the shareholders according to their intent. That means the SPV votes proportional to actual votes (for example, 40/60%, 30/70%, etc.) not as a block that reflects only a majority’s interest (100%).
- Dispersing any proceeds
- Providing tax forms upon an income event to the SPV
It’s important to note that an SPV does not affect voting rights or the number of shares an investor owns. It is simply a mechanism for issuing and managing shares issued during a crowdfunding round.
The company creating the SPV must pay any expenses related to the SPV without passing them along to investors. The SPV must maintain the same fiscal year as the underlying company and issue financial statements annually. The SPV reports are likely to show all zeros until an exit event for the underlying company, but the reports are still required.
An SPV may not borrow money, invest in anything other than the underlying company or change any terms of the investment.
The SPV ensures that investors get the same benefits as if they had a direct investment in the underlying company.
Who can invest through an SPV?
Only natural persons can invest through an SPV, not entities.
How do investors know if they’re investing through an SPV?
When a company manages its crowdfunding raise through an SPV, that fact will be shown on the Form C with the SPV identified as a co-issuer in the offering. Like the company raising funds, the SPV will have its own set of financial disclosure statements. Don’t be surprised by the zeros on those SPV disclosures; afterall, the entity is created to receive and administer investments being made in this funding round. It will not have prior financial events.
How does an SPV impact investors?
With Reg CF, there’s little to no difference for an investor who invests into a company directly or through an SPV, with the exception of potential tax differences.
Are there tax implications for investors?
While many startups that raise through Reg CF are legally structured as corporations, most SPVs are legally structured as an LLC.
The default position of tax laws requires an LLC to issue K-1s to all members any year in which it has revenues or expenses, and each member must pay taxes accordingly. But when an SPV is created to aggregate crowdfunding investments, it has no revenue or expenses until an income or exit event. So the only year you should receive a K-1 or pay taxes would be the year any income or exit disbursement is made. The proceeds of an LLC are taxed as partnership income.
If you had invested directly into the company rather than through an SPV, taxes would still be due upon an exit disbursement. However, they would be subject to the capital gains tax, assuming they had been held for at least one year.
How is an SPV different from a shell corporation?
A shell company has no specific definition; it’s an entity with no history and no business plan. In contrast, an SPV is an entity created for a specific purpose.
In the case of Reg CF investments, an SPV is created to acquire and hold the shares of the underlying company. It’s very different from a shell company because an SPV’s activity is restricted to holding and making the investment into the specific company.
When should a company consider using an SPV?
The decision to raise through an SPV hinges largely on the value of the company’s assets, the type of business and your business plan. SPVs are helpful to companies that want to delay the reporting requirement that’s triggered when you have more than 500 nonaccredited investors or $25 million or more in assets (after a transitional period of about two years).
Are you a software company with minimal items on your balance sheet? Are you a capital-intensive company with large value items on your balance sheet? How close you are to the $25 million threshold. When you reach that threshold, do you plan to be ready for an IPO within two years?
If you’ll reach the reporting threshold soon due to asset value, then it may be better from an administration standpoint to accept direct investments. However, if your balance sheet will show less than $25 million in assets for an extended period, then an SPV may insulate you from triggering the reporting requirements.
Of course, management may have other reasons for deciding to organize crowdfunding shareholders through an SPV, but reporting considerations are often a key factor.
Does the company need to hire an SPV manager?
Not usually. The company that created the SPV usually manages it. If the company chooses to hire a third-party administrator (such as a transfer agent), the company must pay this expense and cannot charge it to the SPV.
Where can you learn more about SPVs for Reg CF?
The SEC has provided some guidance for companies intending to use SPVs in their Reg CF offerings. That guidance can be found here, https://www.sec.gov/corpfin/announcement/staff-guidance-edgar-filing-form-c.
About the Author
Andrew Stephenson is Vice President of Product Management and Strategy for CrowdCheck. He has a wealth of experience assisting companies with understanding and taking advantage of the new landscape of online capital raising. With CrowdCheck, Andrew assists companies through the due diligence and disclosures required when listing their securities with registered broker-dealers and other online securities intermediaries.
This blog article is published by Fundify, Inc. The comments and opinions expressed within are those of the interviewee and do not reflect the opinions and beliefs of the website or Fundify, Inc.