A special purpose vehicle (SPV) is an orphan company or separate legal entity created to isolate risks and reallocate assets to investors.
While SPVs have their own assets, obligations, and liabilities outside the parent company, companies can transfer property ownership to an SPV and sell off that entity, paying (lower) capital gains tax instead of property sales tax.
SPVs, which are also called special purpose entities (SPEs), are advantageous to both companies and established startups, as well as investors. By forming an SPV, the parent company can subsidize the assets and set up separate records for their equity and liabilities.
The SPV typically purchases the elevated risk assets from its parent company. Securitized assets then get grouped into tranches and sold to debt buyers, based on risk tolerance.
In the United States, SPVs are limited liability organizations (LLCs). They can also be a limited partnership (LP) type.
So, it begs the question: Is an LLC or an LP better for a special purpose vehicle?
Read on to find out and learn more.
LLCs vs. LPs: Key Differences
In determining whether to establish an LP or LLC, you will want to be mindful of not only their advantages and potential disadvantages, but also the differences of both types of business structures.
Let's highlight the main differences of both types of business structures first:
The primary differences between the two legal entities lie in the structure. A limited partnership must have two or more individuals where the general partners can make management decisions. Others serve as limited partners, and they are liable for their initial investment alone.
In LLCs, the members can be individuals or business entities. Each LLC will determine the management rights of the members.
The partners in an LP pay federal taxes on personal income through profit distributions. The employees have tax advantages. Profits and losses get distributed to the members in an LLC and pay personal income taxes. But business entities can avoid corporate taxes.
Distribution of profits will vary with LLCs, as it is not based on the contributed capital. LLCs and LPs both pay state income taxes when applicable.
An LP does not provide personal liability protection to general partners. That means general partners can get sued for debts arising from the partnership. The court may decree debt repayment to creditors in the form of personal assets of the general partners.
In contrast, an LLC offers personal asset protection. All the members of an LLC structure are free of the burden of business debts.
The limited partners in an LP enjoy liability protection similar to an LLC.
Most investors in the U.S. usually prefer an LLC.
But, the answer to the question: “Is an LLC or an LP better for a special purpose vehicle?” will depend on your business location. Your LLCs may not be recognized in other countries. If you serve such a country, it is better to opt for the LP form of entity.
The SPV can be styled as private equity or venture capital fund with pro-rata rights. Access to the SPV will be an investment strategy to co-invest with the VC in well-performing companies. LP investors can get additional deal flow with outsize returns.
Best Structure for SPVs
Investors looking to be passive investors without the burden of management can choose LPs. But an LLC can also achieve that by giving control of everyday operations to a manager. In addition, all members of an LLC, both third-party investors and business entities, get full personal liability protection.
Both LPs and LLCs offer similar levels of advantages in terms of tax benefits and asset protection. However, an SPV is usually formed for one purpose alone. So, for an SPV created to hold one investment, an LLC may be the better option. Besides, LLCs are accepted in all parts of the country.