What Is a Special Purpose Vehicle (SPV)?
Special purpose vehicles are special purpose entities that, as the name suggests, serve specific purposes. An SPV is a legal entity with its assets and liabilities and has a distinct identity from its parent company. Parent companies legally isolate a special purpose entity primarily to isolate financial risk and ensure that the subsidiary created can carry out its other obligations even if the mother concern declares bankruptcy.
A special purpose vehicle (SPV) is also a key channel for securitising asset-based financial products such as mortgage-backed securities. Alongside attracting equity & debt investors through securitisation, being a separate legal entity, an SPV also serves as a bankruptcy remote entity for a company, be used to free up capital, transfer specific assets that are generally difficult to transfer, and concerted risk mitigation.
Understanding Special Purpose Vehicles (SPVs)
Risk transferring and isolation are among the most significant aims for creating SPVs. Being a separate company makes it possible for the special purpose vehicle to engage in risky ventures without putting the parent company at risk.
There are several other reasons for creating special purpose vehicles.
- SPVs can be legal entities created to securitise assets.
- They are off-balance sheet entities that can be used to acquire & finance different kinds of assets while cutting down on the associated risks.
- A special purpose vehicle (SPV) can be formed as a trust, a corporation, a limited partnership, or a limited liability company.
- The primary goal is to isolate the risks of the activities undertaken by the SPV from the parent company.
To cite one example, SPVs are used by banks for securitising different kinds of collateral-backed loans and then selling them on the secondary market. This allows them to isolate the risk of those investments and distribute them among their investors.
How Does an SPV Work?
SPVs help keep investment and financing risks isolated from their parent company. The SPV can then securitise assets and raise capital from investors for its projects, thereby mitigating risks and keeping the parent company’s debt obligations secure. The assets or projects better kept off balance sheets are handed over to this special intellectual property.
Uses of Special Purpose Vehicles
1. Risk sharing
A special purpose vehicle (SPV) is a separate legal entity created to isolate risks and distribute them among investors.
2. Securitisation
One of the major uses of SPVs is to securitise risky investment pools. As a result, SPVs are popular vehicles for selling mortgage-backed and asset-backed securities.
3. Asset transfer
Non-transferable or hard-to-transfer assets can be linked and packaged to an SPV, saving costs and preventing hassles during sales, mergers, or acquisitions.
4. Property sale
SPVs are also used to save money on property sales tax. If the tax on a particular asset is way too high compared to the capital gained from selling it off, it’s packaged with an SPV and sold off. The company then pays the tax with higher capital gains.
Raising capital at better rates for future investments, projects & joint ventures, etc., is another primary purpose for creating an SPV.
What is the purpose of an SPV?
Special purpose vehicles are affiliates of their mother concern. They are separate legal entities with assets & liabilities that are kept off the parent company’s balance sheet. These entities are excellent channels for raising capital by securitising debt investments and other asset pools. Assets with high credit risk are securitised and turned into indirect financing sources by bringing in equity investors for debt obligations. The securitisation of asset-backed loan pools is a prime example.
Besides raising capital and risk isolation, SPVs act as bankruptcy remote entities for their parent companies, ensuring fulfilment of debt obligations in case either company becomes insolvent.
As a separate company, SPVs are also used for partaking in joint ventures, engaging in venture capital financing, undertaking risky projects, and even availing tax benefits.
Potential Structures for SPVs
The following five company structures define the forms most SPVs take.
Joint venture:
Companies looking to collaborate on a project can form a special purpose vehicle as a joint venture.
Limited liability company:
The idea behind forming an SPV as a limited liability company is to create a separate legal entity with its identity, rights, liabilities, and responsibilities. In case of insolvency or lawsuit, the parent company can protect its assets and obligations from all the trouble.
Limited partnership:
Akin to joint ventures, limited partnerships exist for short terms. Having an SPV as a limited partner streamlines the entire partnering process and operations.
Public-private partnership:
SPVs are often used as an offshoot of a company looking to enter a venture or project with the government.
Structured investment vehicle:
Structured investment vehicles are special SPVs, built specifically to realise the profits between a company’s debts and securities.
What Are the Mechanics of an SPV?
SPVs are distinct legal subsidiaries businesses use to handle/sell off risky assets from their balance sheet. Securitising said assets and selling them to equity and/or debt investors make SPVs an indirect income source for businesses.
The primary mechanism behind most special purpose vehicles (SPV) is to have a separate legal entity of limited liability, which is then used to securitise certain assets, undertake risky ventures, make tax savings, obtain finances by attracting investors, free up capital gains, and mitigate risks.
What Is the Function of SPVs in Public-Private Partnerships?
When private businesses collaborate with public firms on any project, they generally do so via SPVs. This is because it helps to securely take on risks associated with such projects. In addition, the SPV can act as a buffer for tackling the uncertainties of major, capital-intensive partnership projects.
FAQs
A typical example of an SPV would be a distinct legal entity created by a bank to securitise its pool of asset-backed loans. The SPV attracts investors to invest in those securitised assets, obtaining secondary income and reducing credit risks.
Asset securitisation, risk isolation, raising capital, undertaking risky projects, engaging in partnerships or joint ventures, making tax savings, and circumventing regulations are the many purposes behind creating special purpose vehicles.
The Government of India creates special purpose vehicles to implement its action plans and undertake specific projects. These SPVs will manage, approve, monitor, release funds, and evaluate project outcomes.
The Ministry of Housing and Urban Affairs, Government of India, has created SPVs to initiate its Smart City developmental projects.