Private equity firms often make this costly mistake with SPVs: Here's how to avoid it

24 April 2024
A special purpose vehicle, or SPV, in private equity is a distinct legal entity created for a specific financial purpose, such as holding assets, managing risks, or facilitating deals or acquisitions. SPVs are commonly used to separate financial transactions and protect investors or parent companies from associated risks.

Despite their benefits, private equity firms often make a costly mistake after establishing an SPV. This article describes this common misstep, explains why it happens, and suggests ways to avoid it to promote long-term success in private equity ventures.

The mistake, and a common scenario

Private equity firms may rush to create SPVs to expedite deals or purchases, to meet transactional requirements or for other reasons. In doing so, they may not fully comprehend the long-term ramifications of SPV establishment, including the need to fulfil ongoing compliance obligations. This oversight is understandable, as SPVs are not generally established to conduct business or employ workers, and as a result, they’re less visible or not top of mind for most firms.

SPVs have compliance obligations that are specific to the jurisdictions where they’re established. These obligations typically include ensuring accurate and timely financial reporting, fulfilling tax obligations, and adhering to securities rules. Neglecting these obligations can lead to fines and penalties, as well as potential reputational damage and other consequences.

It’s worth noting that SPVs are typically established by commercial banks or other issuers, who may also undertake fulfilling their ongoing compliance obligations for the purchaser (in our case, a fund). A fund can lose track not only of the number of SPVs they’ve established, but where they’re located, the third parties managing them, and whether or not those third parties are actually fulfilling related compliance obligations.

Anna Coutts-Donald, a director in Vistra's global funds business, says, "I've seen this situation many times. SPVs are set up quickly without much thought across all purchases, often using different third parties to establish the SPVs. Over time, fund managers have multiple providers, and those providers may have different approaches to compliance, data collection and reporting. Untangling and managing all these different vendors and their processes can add significant administrative burdens for the fund manager. Ultimately, compliance obligations may slip through the cracks, leading to significant risk."

How to avoid the mistake

To ensure SPV obligations are met on an ongoing basis, a private equity firm should establish a secure central repository that tracks all information for each SPV, such as entity type, location, related legal documents, financial statements and regulatory filings. The firm should also maintain a compliance calendar to track all SPV obligations, such as tax-filing deadlines.

The firm should develop and implement policies and practices related to SPV management, including designating roles and responsibilities. The team designated to work on SPV management should work closely with legal and tax experts (either in-house or third party) to ensure all SPVs are compliant and necessary.

The policies should also include regular SPV reviews to ensure compliance and ensure that each entity is necessary. Finally, policies should include a process for reporting and escalating issues, as well as for addressing any conflicts of interest.

Depending on the size of a private firm and other factors, a firm should consider hiring a third-party fund administer to the above actions, which are summarised here:

  • Provide a platform that includes a central repository of information
  • Develop and manage the compliance calendar
  • Develop and implement SPV policies
  • Deliver reporting, tax and other services

Hiring a third-party fund administrator will almost certainly in the long run reduce costs, administrative burdens and risks. The fund administrator should also be able to provide ongoing information and advice related to SPV management, including keeping abreast of regulatory developments and industry trends.

Finally, private equity firms should include SPV-related information in their investor reports, including information on SPV compliance status, tax benefits and any potential risks or other pertinent information. The inclusion of SPV information in investor reports can be an important part of promoting transparency and investor trust.