Special Purpose Vehicles (SPVs) are commonly used in private equity fund structures. In this blog, Quantium’s Founding Advisor, Anita Meng, as well as AVP – Client Solutions, Rae Tan, will dive into:
- Advantages of using SPVs
- How SPV look-through differs from SPV non-look through from a fund accounting perspective
- How the effects of lookthrough vs. non-lookthrough can impact fund performance
How are SPVs used in investment structures?
There are a few key reasons GPs use SPVs – such as for tax benefits, or to fulfill specific legal requirements by the LPA/listing regulations. In the past, SPVs were often set up in the Cayman Islands, Ireland, Luxembourg or the British Virgin Islands, but more recently GPs have been turning to Singapore, in particular for investments in the Asia Pacific region.
An advantage of SPVs is that they allow GPs to invest into a portfolio company with capital leverage from co-investors or parallel fund vehicles. For example, let’s say the portfolio company is seeking a $1bn financing round and the GP has several fund vehicles with allocations to participate. A SPV is typically set up to facilitate collection of capital and ongoing management of rights and obligations, on behalf of all investors.
There is another scenario where a SPV could be beneficial. Some LPs may wish to contribute additional capital to co-invest in one specific company, but this isn’t achievable via direct investment through the fund given the fixed allocation in place. Therefore, the GP would set up a SPV to allow certain LPs to co-invest into the company without any disruption to other LPs who are not participating.
What are the main advantages of using SPVs?
From an investor’s perspective, there are several advantages to using SPVs. When used correctly, SPVs can:
1. Provide GPs with more freedom during the transaction process. For example, a SPV can give GPs extra time to raise capital without holding up their purchase agreements with their portfolio companies. A SPV is set up to execute the contract, and in the meantime the GP can continue to raise new capital without interruption.
2. Allow GPs to channel more capital to a particular asset, resulting in greater influence over said asset. E.g., increasing its voting power and rights, thus gaining more control over the invested enterprise.
3. Enable GPs to manage allocations to private investors, staff, and partners.
4. Allow GPs to collect fees and carried interest at the SPV level for additional economic benefits.
5. Filing a SPV as a fund can increase the company’s AUM. For a new GP in the early stages of raising capital, this facilitates easier fundraising with a single underlying target, thus quickly increasing the fundraising amount.
6. Reduce shareholder change impact on the underlying portfolio’s share structure in the post-investment portfolio management process, when investors have changes inequity/shareholding. These changes would only occur at the SPV level, which have no impact on the underlying portfolio.
7. Streamline administration processes. When handling multiple investors or fund entities, only a SPV will need to sign documents.
What complexities do SPVs add to GP operations?
Maintaining a SPV can be complicated, presenting challenges that include:
1. Compliance issues: The guidelines for SPVs are ambiguous, so it is unclear whether a SPV needs to be filed as a fund. This can cause compliance complications. Additionally, in certain jurisdictions (e.g. China), the lookthrough structure can impose limitations on private equity investment from wealth management clients, for whom the number of natural person investors participating in a company is capped.
2. High management costs: When you have a SPV or multiple SPV entities as additional layers, they increase both the administrative costs and manual work required, e.g. bookkeeping, financial reporting and audits.
3. Calculation errors: While some funds use one SPV to invest in a single underlying asset, other funds may use one SPV to invest in multiple assets. This could potentially lead to complications such as incorrect allocation of fees and investments to the SPV’s participants.
These additional complexities make SPVs challenging for GPs to wrangle. For example, a multi-layered SPV structure could lower the accuracy of LP and co-investor capital account calculation if not done correctly. In another example, an accountant could fail to eliminate inter-entity journals resulting in errors in consolidated financials.
Key Considerations for GP Finance Teams
It is important for finance teams to be aware of how SPVs work, the different accounting treatments used and their impacts on fund performance.
From a fund accounting perspective, how does SPV lookthrough differ from SPV non-lookthrough?
There are two methods of setting up SPVs – lookthrough and non-lookthrough. The selected method will depend on the requirements from the LPA or local regulations where the fund is domiciled.
For example, let’s say Fund A invests $100 to a SPV where $80 goes into the asset company and $20 is used for setup fees.
Let’s examine what happens when the asset value goes up to $200 in both scenarios:
Lookthrough: For lookthrough, all asset performance will be directly reflected on the fund level. You have an $80 investment cost with a $120 unrealized gain (2.5x multiple). The $20 is considered to be a fund operation expense.
Non-lookthrough: For non-lookthrough, the investment cost is $100 and the unrealized gain is $100 as well. The return ratio is lower (2x vs 2.5x with lookthrough), however there is no $20 expense for the fund operation. It shows the true metrics of how your $100 has performed.
How does each method impact fund performance?
It is important for fund finance managers to understand that SPV lookthrough vs non-lookthrough can impact fund performance in different ways.
Lookthrough impact on fund performance: Typically, lookthrough figures for FMV, IRR and multiple are higher than non-lookthrough.
However, non-lookthrough shows the true return of the money injected.
Non-lookthrough impact on fund performance: As non-lookthrough will count SPV general fees and impacts the investment Fair Marker Value (FMV). Any investment-related calculations such as FMV, Gross IRR, Multiple of Cost will be affected.
However, fund performance metrics, such as the fund NAV and investor net return, will not be affected.
How can software help GPs manage SPVs effectively?
Many modern GPs manage multi-currency funds and may use both lookthrough and non-lookthrough treatments for different funds depending on the requirements of their various jurisdictions.
When doing cross-fund analysis or preparing fund level financials – for example, consolidated balance sheets for lookthrough – the process is often extremely time-consuming and the complexity of the data means it is easy to make mistakes.
In addition, when the SPV is not 100% owned by the fund (e.g. with 3rd party co-investors), the consolidation calculation can be difficult to manage especially when there is an LP transfer or an LP top-up commitment.
From the LPs’ perspective, they are interested in their consolidated investment performance managed by the GP across fund vehicles, as well as SPVs that may have invested in different countries in multi-currency. Without software to aggregate and auto-calculate the performance returns on individual LP level, GPs would need to spend tremendous amounts of time and effort just to respond to LPs’ ad-hoc requests.
How Quantium software helps automate SPV management
With modern software, SPV management can be streamlined very effectively. With a robust fund management system such as Quantium, GPs can set up different methods for different funds depending on LPA terms or the fund’s domicile.
Financial calculations for each fund, pick-up of the unrealized / realized gain & loss as well as inter-entity elimination can be automated correspondingly, and accurate cross-fund analysis can be as simple as one click – as opposed to updating a full library of interlinked Excel spreadsheets.