Special Purpose Vehicle (SPV)
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 to isolate financial risk. Its bankruptcy remote status reduces the chance that creditors of the parent company can go after its assets.
Special purpose vehicles can be used for a variety of activities, including:
Asset securitization
SPVs are often used in asset-backed securities (ABS) transactions.
The structure isolates the underlying assets from the credit risk of the issuer.
Leveraged buyouts
An SPV may be used to acquire a target company using leverage (debt).
This is called a leveraged buyout (LBO) transaction and is a staple of private equity investing.
The debt is typically non-recourse to the shareholders of the parent company.
Captive insurance
Captive insurance companies are SPVs that insure the risks of the parent company.
Project finance
SPVs are often used to finance large infrastructure projects. The purpose is to isolate the project from the credit risk of the sponsors.
Special purpose vehicles can be structured as corporations, trusts, or partnerships.
They are typically off-balance sheet, meaning they are not consolidated with the financial statements of the parent company.
What is Special Purpose Vehicle (SPV) Company?
Advantages of Special Purpose Vehicles & Why Companies Form Them
SPVs offer several benefits, including:
Risk isolation
By segregating assets and liabilities into an SPV, companies can protect themselves from potential losses.
For example, if an SPV acquires a leveraged buyout target that subsequently goes bankrupt, the creditors may not be able to go after the assets of the parent company.
Increased flexibility
SPVs can be used to tailor financing structures to meet specific needs.
For example, an SPV can be created to issue debt with maturities that the parent company could not get on its own.
Tax benefits
SPVs can be used to minimize taxes. For example, a captive insurance company SPV can be used to deduct premiums paid to insure the risks of the parent company.
Disadvantages of Special Purpose Vehicles & Why Some Companies Avoid Them
Special purpose vehicles also have some drawbacks, including:
Complexity
SPVs can be complex to set up and maintain.
They often require approval from multiple regulatory agencies.
Loss of control
When a company creates an SPV, it gives up some degree of control over the assets in the vehicle.
For example, the shareholders of an SPV that issues ABS may have voting rights over the underlying assets.
Cost
SPVs can be costly to set up and maintain.
Companies must pay fees to the various service providers, such as attorneys, accountants, and trustees.
How Special Purpose Vehicles Work
Special purpose vehicles are created for a variety of reasons, but they all share some common features.
Separate from parent company
First, an SPV is a separate legal entity from the parent company. This means that the SPV has its own management team, board of directors, and charter.
Bankruptcy remote
Second, an SPV is typically “bankruptcy remote”. This means that the creditors of the parent company cannot go after the assets of the SPV in the event of a bankruptcy.
Off-balance sheet
Third, an SPV is typically “off-balance sheet.” This means that the assets and liabilities of the SPV are not consolidated with the financial statements of the parent company.
Structured as a corporation, trust, or partnership
Fourth, an SPV is typically structured as a corporation, trust, or partnership. The specific structure depends on the purpose of the SPV and the jurisdiction in which it is created.
Usually has limited life span
Finally, an SPV typically has a limited life span. Once the purpose of the SPV has been achieved, it is dissolved and its assets are returned to the parent company.
Special purpose vehicles offer several benefits, but they also have some drawbacks. Companies should carefully weigh the pros and cons before deciding to create an SPV.
Enron & The Misuse of SPVs
The Enron scandal was, in part, the result of the misuse of special purpose vehicles.
Enron was a large energy company that used SPVs to hide debt and inflate its earnings. The company created more than 800 SPVs, which were used to transfer assets off of its balance sheet.
This allowed Enron to artificially boost its stock price and deceive investors about the true financial condition of the company.
When Enron’s fraud was uncovered and the firm’s stock collapsed, the company filed for bankruptcy. This resulted in the loss of billions of dollars for investors and employees.
The Enron scandal led to stricter regulation of special purpose vehicles. Now, companies must disclose more information about their SPVs and their financial condition.
Special purpose vehicles can be used for legitimate purposes, but they can also be misused. Companies should be aware of the risks before deciding to create an SPV.
Types of SPVs
Structured Investment Vehicle (SIV)
A structured investment vehicle (SIV) is a pool of investment assets that attempts to profit from credit spreads between short-term debt and long-term structured finance products. SIVs are typically sponsored by banks or other financial institutions.
The assets in an SIV are typically acquired through the sale of short-term debt, such as commercial paper or asset-backed securities.
The proceeds from the debt sales are used to purchase long-term structured finance products, such as collateralized debt obligations (CDOs).
The SIV earns a profit by collecting interest on long-term investments and using the proceeds to pay back short-term debt. The difference between the interest rates on the debt and the investments is known as a “credit spread.”
SIVs were created in 1988, but they became more popular in the 2000s. During this time, there was a large demand for yield enhancement products. SIVs offered investors the potential for high returns with low risk.
However, the financial crisis of 2008 led to the collapse of many SIVs. This was due to the decline in value of the long-term investments, such as CDOs.
As a result of the crisis, SIVs have become much less popular. However, some banks and financial institutions continue to sponsor SIVs.
SPAC
A SPAC is a type of SPV created to raise capital through an IPO (initial public offering) for the purpose of acquiring or investing in other companies. SPACs are often used by private equity firms and hedge funds to take companies public without traditional IPOs.
SPACs have become increasingly popular as a way for companies to go public. For example, in 2020, there were 248 SPAC IPOs (initial public offerings), raising a total of $83 billion. This was more than double the number of SPAC IPOs in 2019, which raised $13.6 billion.
There are several advantages for companies going public through a SPAC.
First, it is typically quicker and cheaper than a traditional IPO.
Second, it allows a company to avoid the scrutiny that comes with a traditional IPO.
And third, it gives a company more control over its share price and who its shareholders are.
There are also some disadvantages to going public through a SPAC.
One is that the company will have to give up some control to the SPAC’s sponsors.
Another is that there is often more dilution for shareholders than in a traditional IPO.
And finally, there is the risk that the SPAC may not be able to find a suitable target company to acquire or invest in.
Whether or not going public through a SPAC makes sense for a particular company depends on its specific circumstances.
But overall, SPACs may provide an attractive alternative for some companies looking to go public.
What is a SPAC? Special Purpose Acquisition Companies Explained
Conduits
A conduit is a type of special purpose vehicle (SPV) that issues municipal bonds to invest in infrastructure and other large-scale projects.
The proceeds from the projects are then used to pay back the bonds.
Securitization Trust
A securitization trust is a type of special purpose vehicle (SPV) that is used to issue asset-backed securities (ABS).
A securitization trust typically acquires loans from multiple sources on illiquid assets (such as housing) and then packages them into ABS.
Infrastructure Investment Trust (InvIT)
An infrastructure investment trust (InvIT) is a type of special purpose vehicle (SPV) that invests in infrastructure projects.
InvITs are typically sponsored by banks or other financial institutions.
The assets in an InvIT are typically acquired through the sale of debt, such as bonds. The proceeds from the sale of the debt are used to finance infrastructure projects.
Real Estate Investment Trust (REIT)
A real estate investment trust (REIT) is a type of special purpose vehicle (SPV) that invests in real estate.
REITs are typically sponsored by banks or other financial institutions.
The assets in a REIT are typically acquired through the sale of debt, preferred stock, and equity. The proceeds from the sale of the debt are used to finance real estate projects.
REITs are often popular among investors because they are legally obligated to give 90 percent of their net income back to shareholders, which gives them higher-than-average yields.
Mortgage Real Estate Investment Trust (mREIT)
A mortgage real estate investment trust (mREIT) is a type of special purpose vehicle (SPV) that invests in mortgage-backed securities (MBS).
The assets in an mREIT are typically acquired through the sale of short-term debt, such as commercial paper or asset-backed securities. The proceeds from the debt sales are used to purchase MBS.
The mREIT earns a profit by collecting interest on the MBS and using the proceeds to pay back the short-term debt. The difference between the interest rates on the debt and the investments is known as a “credit spread”.
Private Equity (PE) Fund
A private equity fund (PEF) is a type of special purpose vehicle (SPV) that invests in private companies.
The assets in a PEF are typically acquired through a combination of investor equity and the sale of debt, such as bonds. The proceeds from the sale of the debt are used to finance private companies.
Venture Capital (VC) Fund
A venture capital fund (VCF) is a type of special purpose vehicle (SPV) that invests in early-stage companies.
VC funds are typically sponsored by banks or other financial institutions.
Bank Loan Portfolio
A bank loan portfolio is a type of special purpose vehicle (SPV) that invests in loans from banks.
Hedge Fund
A hedge fund is a type of special purpose vehicle (SPV) that invests in a variety of assets, including stocks, bonds, commodities, currencies, private companies, collectibles, and virtually anything you can think of.
Hedge fund strategies are often proprietary. They will often short sell as well, which will lower their correlation with the broader market.
The assets in a hedge fund are typically acquired through a combination of investor money and borrowed money.
FAQS – Special Purpose Vehicle (SPV)
How do I set up a special purpose vehicle?
There is no one-size-fits-all answer to this question, as the best way to set up a special purpose vehicle will vary depending on the type of SPV and the jurisdiction in which it is being established.
However, there are some general steps that should be followed when setting up an SPV.
First, you will need to choose the type of SPV that best suits your needs.
Once you have chosen the type of SPV you would like to establish, you will need to find a sponsor. A sponsor is typically a financial institution that provides the initial capital for the SPV.
Once you have found a sponsor, you will need to register the SPV with the relevant authorities.
Finally, you will need to appoint a board of directors and establish the rules and regulations governing the SPV.
What are the benefits of setting up a special purpose vehicle?
There are many benefits to setting up a special purpose vehicle, including:
- SPVs can be used to finance projects that would otherwise be too risky for traditional lenders.
- They can be used to securitize assets and raise capital.
- SPVs can be used to manage risk by isolating certain assets from the rest of the portfolio (such as freezing out creditors from a certain pool of assets).
- They can be used to fund pension plans and other investment vehicles.
- SPVs can be used to structure deals in a tax-efficient manner.
What are the risks of setting up a special purpose vehicle?
There are some risks associated with setting up a special purpose vehicle, including:
- The assets and shareholders of an SPV may be at risk if the SPV is unable to repay its debts.
- The sponsor of an SPV may be liable for the debts of the SPV if the entity is unable to repay its debts.
- The creditors of an SPV may be at risk if the SPV is unable to repay its debts.
Summary – Special Purpose Vehicle (SPV)
A special purpose vehicle (SPV) is a legal entity created to achieve a specific goal.
SPVs are often used by companies to protect themselves from potential losses, minimize taxes, and increase flexibility.
However, SPVs can be complex to set up and maintain, and they can cost a company ordinary control over its assets.
The Enron scandal was partially the result of the misuse of SPVs. Before creating an SPV, a company should carefully consider the pros and cons.