I often talk to entrepreneurs who are planning to implement their first project of building and selling premises. During the consultation, they always ask the same three questions:
In this article, I will focus on answering this last question. So, should you implement a development project as a so-called JGD (sole proprietorship) or as a special purpose vehicle? What do the first and second options involve?
Below you will learn, among other things:
A special purpose vehicle is simply a newly created entity, most often in the form of a limited liability company, whose task is to carry out a specific project.
It is a company created for a precisely defined purpose, hence the name "special purpose". It should not be confused with a civil partnership, because it is something completely different.
You can also come across the English name of a special purpose vehicle. SPV (Special Purpose Vehicles) is a special purpose vehicle established for the purpose of implementing a specific project.
A special purpose vehicle allows for all costs, revenues and all risks associated with the implementation of a given project to be separated into a separate entity. It has no history, liabilities, loans and no legal disputes are pending against it. These are very important issues that banks and investors pay attention to.
The specificity of development projects is that they last for a specified period, e.g. 18, 24 or 36 months, and then the company that carries them out suspends its operational activity. It can be said that it has fulfilled its main task, so it is no longer needed. It limits its activity to managing all post-construction risks, providing warranties and guarantees for the next 5 years.
Plot of land for development investment. Second stage of its purchase – conditional agreement
A special purpose vehicle does not operate in a vacuum. It is created by private individuals, as well as other partners, who may also be other companies. In the case of a larger number of investments, it is common practice for individual special purpose vehicles to operate within a single capital group in a holding structure.
In such a situation, we have a so-called "parent company", which is the dominant entity, and several or a dozen special purpose companies established to implement specific projects.
From my point of view, running a development investment as a sole proprietorship is a very risky and tax-inefficient activity. But that's not all. Below I list more factors that should be taken into account when thinking about running a development business safely.
I treat a special purpose vehicle as a kind of tool, the use of which causes lower risk, greater tax efficiency and transparency of the implemented project. I am also not limited by the number of companies established and the structure of shareholders who decide to do business together.
Running a sole proprietorship, you can operate in one or several industries, but everything you do goes to your single joint account. Risk is centralized from every area in which you operate, because you are also responsible for everything you do with your own assets. Every venture, every new business will have an impact on all the others.
A development project should be separately accounted for and have a transparent cost and revenue structure. You will then be able to properly assess and continuously monitor its profitability. If something goes wrong in this one project, other areas of your business will not suffer.
However, if you "throw everything into one bag", you may even lose track of what you are actually making money on and what you are losing on.
Running a sole proprietorship will have higher tax costs. You can't count on the 12% tax, because running a development business, you probably won't get it, so you're left with 19% or the tax scale.
In addition, it is necessary to mention all kinds of “extra” charges, e.g. health insurance premium calculated on income…
In a special purpose vehicle operated as a limited liability company, you will have a 9% CIT tax up to 2 million euros in revenue, and after exceeding this limit, the CIT is 19%. In addition, the profits generated by the project are usually reinvested, and in such a situation, the 19% dividend tax will not apply to you.
The profits you need for your own needs can be “drawn out” of the special purpose vehicle by invoicing specific costs for business activity. Running a company or special purpose vehicles does not exclude running your current business activity in parallel.
You can set up a special purpose vehicle online in 1-2 hours by paying a fee of PLN 350.
If you need a non-standard company agreement or you are contributing equity capital in kind, then a visit to the notary will be necessary. This is then associated with slightly higher costs and requires more time. It is also possible to open a special purpose company via the Internet and later make changes to the agreement at the notary.
The costs of accounting services for a sole proprietorship are usually half of those for a special purpose vehicle. If maintaining a KPiR (revenue and expenses book) costs around PLN 400-500 per month, then in a company of this type the costs may be twice as high.
On the other hand, when running a single-family home (JGD), you must pay monthly social security contributions to ZUS (in February 2023, this is PLN 1,418.48). When running a special purpose vehicle in the form of a limited liability company, with a two-person management board, you do not have to pay such contributions!
There is no way that a bank will give you a loan for a development project that you want to implement as part of your current business activity. This is a completely different financing methodology, financial risk and forms of security.
Loans that banks grant for already operating businesses are most often based on the so-called income methods, i.e. based on the generated income for the last closed settlement period (except for investment loans). Loans for development projects are based on the so-called financial project , i.e. future income from the sale of premises.
Investors also do not accept capital cooperation with people running JDG. No one considers "mixing" private assets with a business venture.
Download Excel Sheets and check the profitability of your planned project
When running a self-employed person, you are responsible for everything you do with all your private assets! This also applies to things that you have no influence over, such as changes in legal regulations, payment backlogs, construction accidents, court proceedings, etc.
Imagine a situation where a serious, God forbid fatal accident occurred at a construction site. The injured party's family filed a civil lawsuit against you, which they won. You are required to pay compensation of PLN 1 million. What will you do in such a situation?
You run a sole proprietorship and you are a company building photovoltaic farms, and you are also implementing a small development project. You have a legal dispute with a contractor that ends unfavorably for you. At some point, your bank accounts (corporate and personal) are seized by a bailiff to fulfill the enforcement order. You lose access to all your own cash!
What's more, it may turn out that the amount of the enforcement is significant and cannot be satisfied from the funds in bank accounts. Then the bailiff will start to claim the required amount from fixed assets, e.g. private real estate, but also from the project you are implementing.
If there is a bank mortgage on the property, the bank will also terminate your loan agreement to "get in line with creditors" for their money... In such a situation, you would not be able to complete the project.
If a similar situation occurred in one, second or third special purpose vehicle, the enforcement seizure would be limited only to the account and assets of that specific vehicle. Your private funds and other assets would be safe.
All post-construction risks and those arising from guarantees or warranties are borne by the person conducting the business activity for 5 years, and in the case of a special purpose vehicle, the company is liable for them.
Finally, it is worth considering what would happen in the event of the death of a person running a sole proprietorship who is implementing a development project. In the event of such an event, when the project is implemented by a company, the death of the partner or shareholder will not result in bankruptcy and failure to complete the investment. In the case of sole proprietorships in this type of situation, bankruptcy is more than certain.
What then about the Clients who have so far paid half or most of the funds to the developer for the purchase of the apartment? What's more, they often did it with a bank mortgage. In practice, they are left without an apartment, with the need to repay the loan, not to mention the psychological consequences of such a situation.
This is not a hypothetical situation. As life has shown, such things happen. A link to an article that describes the situation of the Clients of the owner of “Pajo” – PW Deweloper can be found here.
Pajo was once one of the fastest growing developers in Plewiska near Poznań. The company quickly increased its scale of operations, implemented more and more projects, but today it is history…
You can find more about developer finances here on this page of my blog, and if you would like to consult with me about your project, please contact me on this page.
Further discussion on special purpose vehicles (practical issues) will be available soon in subsequent publications.
I wish you many successful projects,
Paul Pilarczyk