A Special Purpose Vehicle (SPV) is a separate legal entity created by an organization. The SPV is a distinct company with its own assets and liabilities, 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, 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. Moreover, in some cases, it is required that the SPV should not be owned by the company on whose behalf the entity is created.
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 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.
4. Property sale
If the taxes on property 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
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
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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