Given the continued and growing interest in special purpose vehicles (“SPVs”) as a means of accessing private market investments, we are publishing a series of posts that examine different aspects of these structures. This is our third post in the series, exploring structuring and regulatory issues that arise when SPVs are formed to invest in other SPVs.
In our prior posts on single-investment SPVs, we discussed the primary structures SPVs use to accomplish their objective of providing indirect or synthetic exposure to their reference investment. Adding another level of abstraction, some sponsors form SPVs that invest in other SPVs. In this post, we consider the legal and regulatory issues these double-layer structures present.
Throughout this series, we considered the fictional company TechCo and hypothetical SPV structures that would invest either directly or synthetically in TechCo’s common stock. Now consider the following scenario:
- SPV-1, a Delaware limited partnership, holds TechCo common stock it acquired using the proceeds from the offer and sale of SPV-1 limited partnership units to SPV-1’s limited partners.
- SPV-1 owns 1% of TechCo’s outstanding common stock.
- SPV-2, also a Delaware limited partnership, purchases limited partnership units of SPV-1 using the proceeds from the offer and sale of SPV-2 limited partnership units to SPV-2’s limited partners.
- SPV-2 owns 10% of the limited partnership units of SPV-1.
- TechCo has a valuation of $10 billion.
In this scenario, SPV-1 owns $100 million of TechCo common stock. SPV-2 does not own any TechCo common stock but does have an indirect interest in $10 million of TechCo common stock, i.e., SPV-2 has an indirect 0.1% interest in TechCo.
Through the Looking Glass
As mentioned in our introductory post, sponsors must consider when to look through entities, how to treat investors that rely on similar exemptions and whether affiliated vehicles should be integrated. The Section 3(c)(1) exemption under the Investment Company Act generally limits a fund to no more than 100 beneficial owners. One motivation to form a double-layer structure is to work around that investor cap: if SPV-1 already has 99 investors, it might have headroom to admit SPV-2 as a limited partner and thereby provide economic access to several additional investors (SPV-2’s LPs) who would not be able to invest directly as SPV-1 LPs. However, the look-through rules are complex, and a full discussion of them is beyond the scope of this series. If SPV-1 and SPV-2 both rely on the Section 3(c)(1) exemption and the look-through rules require SPV-1 to “look through” SPV-2 to its beneficial owners, then the LPs in SPV-2 could count against SPV-1’s 100-beneficial owner limit, and SPV-1 risks inadvertently exceeding that limit. For this reason, it is important for SPV planners and their legal counsel to pay careful attention to the complex and often intricate provisions of the Investment Company Act and related SEC rules governing fund formation.