Special Purpose Vehicles (SPVs) are affiliate legal entities of a parent company that are not vulnerable to financial risks. Also called Special Purpose Entities (SPEs), SPVs are formed during a limited business acquisition. Since it is considered a separate company, it remains secure even if the parent company files bankruptcy.
This bankruptcy-remote entity is preferable in various financial situations. But before knowing the circumstances when you can consider it, you must know how it works.
Read on to learn about how a special purpose vehicle is set up and its benefits.
How a Special Purpose Vehicle Functions
The SPV has its balance sheet, although it is a subsidiary of a parent corporation. It becomes an indirect source of funds and attracts independent equity investors. So, it helps the original corporation find debt purchasers for long-term credit obligations.
When an SPV forms, it purchases the risk assets from the parent organization. After grouping them into specific credit risk preferences, it finds different types of debt buyers.
How Is a Special Purpose Vehicle Formed?
In the U.S., special purpose vehicles created are mostly limited liability corporations (LLCs). Capital-raising SPVs can also be limited partnership (LP) entities. It can form with the same requirements as these entities.
How a special purpose vehicle is set up depends on the transferred assets’ market value. The parent company sells some assets to raise funds for the SPV. By paying over 3% of the “at-risk” investment, an independent third-party becomes its legal equity owner. The investors get paid in highly-rated investment-grade securities that bear interests for the assets purchased.
When Can You Use Special Purposes Vehicles?
From protecting the parent company from liabilities as well as insolvency or bankruptcy, SPVs offer many benefits. They are excellent ways to raise capital and do not have the original organization’s regulations.
Here are some common reasons to create an SPV:
A company can isolate the significant risks of a project and share it among other investors.
A company can let the SPV own the assets that are hard to transfer. When it is time to move the assets, it can simply sell the SPV.
If the property sale taxes are higher than the capital gain, a company has another option. Instead of selling the properties, it can sell the SPV and pay tax on the capital gain.
For instance, high-risk loans can be separated by the bank. The company offers investors these mortgage-backed securities.
Since the SPV has fewer statutory requirements, it has more freedom to operate. The parent company has more options in making asset allocations without having to reveal them to investors.
The parent corporation can make high-risk future investments and current transactions without fearing insolvency. Creditors buying the assets have protection as the SPV doesn’t get affected by the entire company.
The special purpose vehicle has a separate balance sheet to record its assets and liabilities. Debt and equity also remain isolated from its parent company, with limited capitalization and no independent managers. When the risk of bankruptcy is high, it is better to use an off-balance-sheet SPV.