The image source is Envato.
Being a small family business owner can be liberating and allow one to work towards one’s dreams without being stuck in a stringent corporate environment. However, the downside to that business model is that small business owners take on not only all the potential profits from their ventures, but also all the risk when things go wrong. When the unexpected happens, like the mass economic shutdowns due to the coronavirus pandemic, small family business owners must learn how to most effectively preserve their capital and mitigate financial risk, both personal and financial. In these cases, SPVs can be immensely helpful.
Learning About an SPV
You might ask yourself, “What is an SPV?” An SPV (special purpose vehicle) is a separate legal entity created under the control of a larger parent organization, whose sole goal is to help the business at large minimize legal and financial risks incurred during operations. According to the Corporate Finance Institute, SPVs can successfully isolate risk because they only buy and sell a specific type of corporate asset and are created to focus on a single business purpose. This means that if the parent company goes bankrupt, the SPV can still conduct its business as usual because its operations, assets, and liabilities are completely separate from those of its parent company from a legal standpoint. The opposite is also true – if the SPV falls on hard financial times, the parent corporate entity does not need to assume the debts of the SPV and can still operate if it is on a good financial footing.
Benefits and Risks of SPVs
As with any business venture, choosing to operate through a SPV comes with its share of benefits and downsides. Main benefits, according to the Corporate Finance Institute, include the ability to isolate financial risk between projects or different parts of the business, continued direct ownership of an asset, tax savings if the SPV is created in a jurisdiction with lower tax rates, and simply how easy it is to set one up. Downsides to establishing SPVs range from finding it harder to raise capital, as SPVs tend not to share the parent company’s credit rating, and potential problems arising from regulatory changes. Given the fact that most small business owners will not need to set up a number of SPVs to shield risk on numerous projects, small businesses will tend to benefit more from these vehicles than experience much of the downside.
Why Do Small Businesses Need Asset Protection Through SPVs?
If you are operating a small business without setting up a separate legal entity to own your business assets, then you are putting your own personal and your family’s private assets at risk. You might think that your business doesn’t bring in enough profits every year to warrant setting up a whole other entity for your venture and instead elect to keep your business as a sole proprietorship. Many small business owners do not want to go through the hassle of registering their business under a separate legal entity, which involves filling out a series of documents and paying a fee. Moreover, the most popular type of SPV is an LLC and unless you as the business owner decide to elect corporation status, you will still need to pay the same pass through tax rate as a sole proprietorship.
Small business owners who do not understand the intricacies of the legal protection that having an SPV affords, then, may choose not to act. During good times, this may not be very problematic. The trouble comes when unexpected circumstances severely impact your small business’s income or makes it impossible to operate. In the pandemic’s case, for example, many restaurants shut down. Once restrictions like rent moratoriums are lifted, small business owners without the protection of an SPV may see creditors come after their personal assets, like their family home, if they are unable to make their debt obligations.
Many small family business owners do not understand the importance of keeping their business income, assets, and liabilities shielded away from their private property in an SPV. When times are good, the importance of having a separate legal entity becomes less apparent. HOwever, when creditors come after your personal assets to cover losses from business debts, it will be too late to protect yourself. Thus, it is important to cover your bases by exploring the right SPV for your small family business as soon as possible.