Why Would Companies Create Special Purpose Vehicle?

What Is a Special Purpose Vehicle (SPV)?

A special purpose vehicle (SPV), also known as a special-purpose entity (SPE), is a legal entity created by the parent company for a specific task or project. This subsidiary shields the parent company from financial risk, including bankruptcy. Thus, if the parent company goes bankrupt, SPV continues its business without any problem. This is the reason why an SPV is often called a bankruptcy-remote entity. SPV has its own assetsliabilities, and its legal status.

Why would a company create an SPV?

There are several reasons why companies create SPVs. First, SPV is created to securitize assets in a separate company while undertaking a risky project. In this case, the goal is to secure the parent company from the most severe risks of its failure and share the risk with other investors. Moreover, it is not easy to transfer some types of assets. So, companies create an SPV to have the right to own these assets. If they need to transfer the assets, they can quickly sell the SPV as part of a merger and acquisition (M&A) process. Unlike parent companies, SPVs have much freedom on an operational level. Thus, they do not struggle with many regulations as head companies do.

How an SPV Works

SPV has its own liabilities, assets, and obligations. For instance, when SPVs want to raise extra capital, they can issue bonds at better borrowing rates.

A parent company may wish to keep certain projects or assets off its balance sheets in order to avoid the financial risks that these assets may entail. By forming a special purpose vehicle, the company can isolate the assets and securitize them by selling shares to investors.

Once the company has established an SPV, it uses debt finance and individual equity investors to raise funds to purchase the assets from the parent company. The assets become the collateral for the securities issued because the SPV now owns them. Therefore, investors and lenders can assess the firm based on the quality of the collateral rather than the parent company’s creditworthiness, potentially lowering financing costs.

By attracting independent equity investors to help purchase debt obligations, the SPV becomes an indirect source of financing for the parent firm.

Usually, financial information about an SPV does not appear on the parent company’s balance sheet. All financials are kept only on their own balance sheet. Indeed, such hidden information might be good for the parent company but not for the investor. Investors will not be able to take a deep look at the company’s financial situation in this way. It would be wise to check the parent company’s balance sheet and its SPVs before investing in any company. 

Expected benefits of Special Purpose Vehicles 

  • SPV has a separated financial risk. The special purpose vehicle is a bankruptcy-remote entity, which means that its insolvency and the parent company’s insolvency cannot jeopardise each other’s financial situation.
  • You will have an ownership right to a specific asset.
  • SPV is easy to create and set up. For specific assets, SPVs make the securitization process easier and more cost effective than selling individual assets.

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