A special purpose vehicle (SPV) is a legal entity that is created by a parent company for a specific purpose, such as undertaking a risky project, securitizing assets, or raising capital. An SPV is separate from the parent company and has its own balance sheet, assets, liabilities, and equity. By using an SPV, a company can isolate financial risks, protect its assets, and achieve various business objectives. In this article, we will explain the main reasons why companies use special purpose vehicles and how they work.
Isolating financial risks
One of the main reasons why companies use special purpose vehicles is to isolate financial risks from the parent company. For example, a company may create an SPV to undertake a risky project, such as developing a new product, entering a new market, or acquiring another company. If the project fails, the SPV will bear the losses and liabilities, while the parent company will be shielded from the negative consequences. This way, the parent company can pursue new opportunities without jeopardizing its existing operations and reputation.
Another example of isolating financial risks is securitizing assets, which means converting assets into securities that can be sold to investors. A company may create an SPV to transfer its assets, such as loans, mortgages, or receivables, to the SPV, which will then issue securities backed by those assets. The SPV will pay the interest and principal to the investors, while the parent company will receive the proceeds from the sale of the securities. This way, the parent company can improve its liquidity, diversify its funding sources, and reduce its exposure to credit risk.
Protecting assets
Another reason why companies use special purpose vehicles is to protect their assets from creditors, regulators, or competitors. For example, a company may create an SPV to hold its intellectual property, such as patents, trademarks, or trade secrets, and license them to the parent company or other entities. This way, the parent company can safeguard its valuable assets from being seized, infringed, or disclosed by third parties.
Another example of protecting assets is creating an SPV to hold a minority stake in another company, such as a joint venture partner, a supplier, or a customer. This way, the parent company can maintain a strategic relationship with the other company, while avoiding the risks and obligations of being a direct shareholder.
Achieving business objectives
A third reason why companies use special purpose vehicles is to achieve various business objectives, such as tax optimization, regulatory compliance, or market access. For example, a company may create an SPV in a low-tax jurisdiction, such as Ireland or Singapore, and transfer its profits or assets to the SPV, which will then pay lower taxes or no taxes at all. This way, the parent company can reduce its tax burden and increase its profitability.
Another example of achieving business objectives is creating an SPV to comply with the local laws or regulations of a foreign country, such as China or India, where the parent company wants to operate. For instance, some countries may require a foreign company to have a local partner, a minimum capital, or a certain ownership structure to do business. By creating an SPV that meets these criteria, the parent company can enter the foreign market and benefit from the opportunities there.
How do special purpose vehicles work?
The process of creating and using a special purpose vehicle may vary depending on the type, purpose, and structure of the SPV. However, the general steps are as follows:
- The parent company identifies the purpose and the scope of the SPV, such as the project, the assets, or the business objective that it wants to achieve.
- The parent company chooses the legal form and the jurisdiction of the SPV, such as a corporation, a trust, a partnership, or a limited liability company, and the country or the state where it will be registered and operate.
- The parent company transfers the assets, the liabilities, or the equity to the SPV, either by selling, lending, or contributing them to the SPV. The parent company may also provide guarantees, services, or management to the SPV.
- The SPV issues securities, such as bonds, notes, or shares, to the parent company or to other investors, who will provide the funding for the SPV. The SPV may also obtain loans or other forms of financing from banks or other lenders.
- The SPV performs the activities that it was created for, such as executing the project, securitizing the assets, or achieving the business objective. The SPV pays the interest, the principal, or the dividends to the investors, and reports the results to the parent company and the regulators.
- The SPV is dissolved or liquidated once it completes its purpose, or when the parent company decides to terminate it. The SPV returns the remaining assets, liabilities, or equity to the parent company or to the investors, and settles any outstanding obligations or claims.
Special purpose vehicles are useful tools for companies that want to isolate financial risks, protect their assets, and achieve their business objectives. By creating and using an SPV, a company can pursue new opportunities, improve its financial performance, and comply with the legal and regulatory requirements. However, an SPV also involves some challenges and risks, such as complexity, transparency, and governance. Therefore, a company should carefully weigh the pros and cons of using an SPV. Contact us for more information on setting up your special purpose vehicle.
Published: 2/17/2024 8:11:01 AM
