A Special Purpose Vehicle (SPV) is a separate legal entity created by an organization. The SPV is a distinct company with its own assets Types of Assets Common types of assets include current, non-current, physical, intangible, operating, and non-operating. Correctly identifying and and liabilities Liability A liability is a financial obligation of a company that results in the company’s future sacrifices of economic benefits to other entities or businesses. A liability can be an alternative to equity as a source of a company’s financing. , as well as its own legal status. Usually, they are created for a specific objective, often to isolate financial risk. As it is a separate legal entity, if the parent company goes bankrupt Bankruptcy Bankruptcy is the legal status of a human or a non-human entity (a firm or a government agency) that is unable to repay its outstanding debts to creditors. , the special purpose vehicle can carry on.
A special purpose vehicle can be a “bankruptcy-remote entity” because the operations of the entity are restricted to the purchase and financing of specific assets or projects.
The typical legal forms of special purpose vehicles are partnerships, limited partnerships, or joint ventures Joint Venture (JV) A joint venture (JV) is a commercial enterprise in which two or more organizations combine their resources to gain a tactical and strategic edge in the market. Companies often enter into a joint venture to pursue specific projects. The JV may be a new project or new core business . Moreover, in some cases, it is required that the SPV should not be owned by the company on whose behalf the entity is created.
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Uses of Special Purpose Vehicles
The following are the most common reasons for creating SPVs:
1. Risk sharing
A corporation’s project may entail significant risks. Creating an SPV enables the corporation to legally isolate the risks of the project and then share this risk with other investors.
Securitization of loans is a common reason to create an SPV. For example, when issuing mortgage-backed securities Mortgage-Backed Security (MBS) A Mortgage-backed Security (MBS) is a debt security that is collateralized by a mortgage or a collection of mortgages. An MBS is an asset-backed security that is traded on the secondary market, and that enables investors to profit from the mortgage business from a pool of mortgages, a bank can separate the loans from its other obligations by creating an SPV. The SPV allows investors in the mortgage-backed securities to receive payments for these loans before other creditors of the bank.
3. Asset transfer
Certain types of assets can be hard to transfer. Thus, a company may create an SPV to own these assets. When they want to transfer the assets, they can simply sell the SPV as part of a merger and acquisition (M&A) process Mergers Acquisitions M&A Process This guide takes you through all the steps in the M&A process. Learn how mergers and acquisitions and deals are completed. In this guide, we'll outline the acquisition process from start to finish, the various types of acquirers (strategic vs. financial buys), the importance of synergies, and transaction costs .
4. Property sale
If the taxes on property Real Estate Real estate is real property that consists of land and improvements, which include buildings, fixtures, roads, structures, and utility systems. Property rights give a title of ownership to the land, improvements, and natural resources such as minerals, plants, animals, water, etc. sales are higher than the capital gain realized from the sale, a company may create an SPV that will own the properties for sale. It can then sell the SPV instead of the properties and pay tax on the capital gain from the sale instead of having to pay the property sales tax.
Benefits and Risks of Special Purpose Vehicles
- Isolated financial risk
- Direct ownership of a specific asset
- Tax savings, if the vehicle is created in a tax haven such as the Cayman Islands Top Banks in the Cayman Islands There are 158 banks in the Cayman Islands, the majority of which are branches and subsidiaries of international banks. The Cayman Islands is one of the leading international financial centers in the world. Over 80% of more than US $1 trillion of deposits
- Easy to create and set up the vehicle
- Lower access to capital at the vehicle level (since it doesn’t have the same credit as the sponsor)
- Mark to Market accounting rules could be triggered if an asset is sold, significantly impacting the sponsor’s balance sheet Balance Sheet The balance sheet is one of the three fundamental financial statements. These statements are key to both financial modeling and accounting. The balance sheet displays the company’s total assets, and how these assets are financed, through either debt or equity. Assets = Liabilities + Equity
- Regulatory changes could cause serious problems for companies using these vehicles
- The optics surrounding SPVs are sometimes negative
Learn more from Wharton about special purpose vehicles and why companies use them.
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