What Is A Special Purpose Entity?
Richard Colosimo: Mike, thanks for joining us today. In your career, you’ve been a consultant and a CFO and an M&A professional, and an investor and founder. Today, I’m hoping you can give us some advice for people entering into small investment partnerships, which typically take the form of a special purpose entity. Let’s dive right in—what exactly is an SPE, and why do investors use them?
Michael Princi: Glad to be here. A special purpose entity, or SPE, is a legal entity created to fulfill a specific, narrow purpose—typically to hold a single investment or asset. They’re used across many sectors and especially in real estate and private equity of all kinds. Most people will see these in smaller deals. In big deals, they’re used but only in the corporate org chart of a deal; typical investors are limited partners in a venture or PE fund that is a limited partnership. But in smaller deals, such as when a bundler is bringing a number of investors together in a single entity to make an investment in a portfolio company, that entity will almost always be an SPE (or should be!).
An all but mandatory feature is that they’re “bankruptcy remote.” That means the entity is legally isolated from the parent company’s financial troubles (or those of its portfolio company). If something goes wrong with the sponsor – the investors, creditors generally can’t go after the assets inside the SPE. This insulation makes SPEs ideal for managing risk for investors in these kinds of multiple-investor entities.
How Do SPEs Operate?
Rick: That sounds important if you’re investing with other people. So, how do SPEs typically operate?
Mike: Most SPEs are and should be passive. They’re not businesses that sell goods or offer services. Instead, they hold something—often equity in a real estate development, a subsidiary company, or a portfolio of assets. There should be no day-to-day activity and very limited monthly activity.
Because of that, you won’t see regular income or operating cash flows during the life of the investment. The most common cash transactions would be:
- Capital contributions (inflows) from investors, usually at the start or occasionally for planned expenses.
- Capital investment (outflows) into the portfolio investment.
- Operating income distributions (inflows from the portfolio investment)
- Tax distributions (inflows and outflows) to cover pass-through tax obligations for the SPE or investors, respectively.
- Liquidating distributions at the end, when the underlying investment is sold or exited.
Rick: It seems like SPEs aren’t designed to generate cash during the holding period.
Mike: Right. An SPE is usually not an income-generating engine. All the capital flows into the investment. It often doesn't flow back out until there's an exit. If you’re managing one, you can’t just assume you can count on internal cash flow to cover even basic costs—like tax filings or accounting fees.
How Are SPEs Funded?
Rick: That brings us to financial planning. What sort of costs do SPEs typically face, and how should they be funded?
Mike: Great question. Even “quiet” entities incur costs. For example:
- Annual tax prep
- State filing fees
- Audit or financial statement preparation
- Legal maintenance, especially for compliance
These costs might be small individually, but they add up over time. If the entity doesn’t generate operating income, the manager needs to plan beforehand how those expenses will be paid. Will you hold back a reserve? Will you do capital calls? Do you have an agreement to fund these costs through another affiliated entity?
If you don’t plan ahead, you’ll hit a big pothole when the bills come due.
What Should SPE Managers Watch Out For?
Rick: What are some of the traps that trip up SPE managers?
Mike: One of the biggest traps is taking on debt that requires regular payments. If you’re using leverage in an SPE, you need to be very clear in your mind about how interest and principal will be serviced. If the investment isn’t generating cash, then you’re setting yourself up for a default unless you’ve already raised additional capital to cover debt service. And from a corporate finance perspective, raising equity at a high WACC to cover debt service at a low WACC points to a structural problem with how the whole investment has been designed. Debt is a real problem because there’s an outsider who is going to want those payments on time every month.
Another common trap is signing up for obligations that assume future operating cash flow—things like fixed management fees, ongoing service contracts, or even routine overhead. Those only make sense in a company that has operating revenue, which the SPE doesn’t. They have to be managed tightly from a cash flow perspective, and to be done right, you have to plan for it in advance.
These two problems showcase situations where failure to plan is planning to fail.
Preventing Problems
Rick: So does the cash flow statement help here?
Mike: Yes. The cash flow statement is your best friend in understanding where you stand. It has three sections:
- CFO (Cash Flow from Operations) – usually zero in an SPE.
- CFI (Cash Flow from Investing) – mostly shows outgoing flows to acquire or improve assets.
- CFF (Cash Flow from Financing) – where new equity or debt comes in or is paid off.
If your CFO and CFI are not producing new cash, which is *what is expected,* then the only source of new cash is CFF—bringing in money from outside. That’s why it’s so important to structure your SPE carefully and communicate expectations to investors early, before you bring money in. If you’ll need additional equity in year 3 for legal or tax work, that better be in the plan. No one likes surprises that didn’t have to be surprises.
Rick: Let’s talk about financial controls. What kind of controls should a well-managed SPE have?
Mike: Even if your SPE has no regular operations, you still need solid financial controls. These include:
- Monthly financial statements – even if they show little activity, transparency builds trust. You can’t manage what you don’t measure.
- Clear documentation of all capital flows – when money came in, where it went, and what’s still available.
- A financial forecast or capital plan – this should show expected cash needs, such as filing costs, legal fees, and reserve planning. For an SPE, this *is* something you can plan. Remember, it’s not an operating business.
The more passive the entity, the more important it is to plan ahead and also communicate proactively. Investors may forget that the entity needs even a few thousand dollars a year to stay in good standing.
Avoiding Insolvency
Rick: Suppose you didn’t plan well—what happens when an SPE runs out of cash?
Mike: That’s when things get uncomfortable. If you haven’t reserved enough or communicated the need for future capital, you have limited options. You may need to:
- Call for more equity from your existing investors—which can be tough if the request is unexpected.
- Bring in bridge financing, if appropriate—but again, you’re borrowing into a non-cash-generating entity.
- Fund expenses personally or through a sponsor, which may not be feasible or fair. These approaches require a mechanism to recapture them, which means more expenses if it’s not already in your documents.
This is why early planning and ongoing communication are critical. Solvency isn’t just about having more assets than liabilities—it’s more often about having enough liquidity to meet obligations as they come due. You can have $20m in stock in a unicorn startup, but if you don’t have $5000 for tax prep for the SPE and investors, you’re technically insolvent.
Rick: And that label can cause all kinds of mischief across multiple levels and contracts. How can an SPE manager avoid getting to that point?
Mike: A few best practices go a long way:
- Model out all expected expenses over the life of the entity, and include a contingency factor, a cushion for unexpected expenses.
- Hold back reserves from the initial capital raise to cover non-investment costs. This way, you solve the problem once, upfront.
- Establish a formal capital call policy, even for minor costs—so no one is surprised later. Without a mechanism, everyone is forced to figure out a plan and then get people to agree. That takes time and money that certainly weren’t in your budget either.
- Issue financials regularly, and make sure your cash position is always clear.
And most importantly, never assume there will be operating cash flow or future raises to rely on. If you treat every dollar you hold as all you’ll get, you’ll stay disciplined.
Final Advice
Rick: Final thoughts for people working with SPEs?
Mike: Don’t be lulled into thinking “passive” means “low maintenance.” SPEs require careful design and active oversight, especially around capital planning and financial control. If you handle the cash flow side with foresight and transparency, your SPE will do exactly what it’s meant to: quietly and efficiently serve a specific purpose, without surprises.
Rick: Thank you! This was incredibly insightful.
Mike: Glad to help. If more investors understood the inner workings of SPEs, we’d see far fewer problems down the road.
Michael Princi is an experienced owner, operator, investor, and advisor who brings a practical, disciplined approach to building and scaling businesses. A graduate of West Point and former Army officer, he applies clear thinking and structured leadership to help companies align strategy with execution. Through his work with CerteVerus AI and Thoughtstorm, Michael partners with founders, executives, and investors to unlock value, improve performance, and drive sustainable growth. You can find Mike at .
If you have any questions about this article, using SPEs, a manager’s duty to carry out long-term planning, or how to project and plan your cashflow, please contact Richard J. Colosimo, Esq. ( or 908-964-2480).
