What is an SPV Fund and How Do They Help Your Business?
Monday, February 17, 2020, 6:00 PM | Leave Comment
SPVs, or Special Purpose Vehicles, are independent legal entities created by businesses to manage specific activities.
There are many advantages to creating an SPV and many ways to go about it.
How do you know if this is the right move for your organization?
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Understanding SPVs
It is first important to understand how an SPV works for your business. SPVs are established as independent, legal entities with their own obligations, assets, and liabilities. Organizations typically use an SPV fund, also sometimes referred to as a Special Purpose Entity (SPE), to protect assets or isolate risk.
Due to the fact that an SPV has its own balance sheet, the assets held in the SPV are protected from the activity of the parent company. This means that if your parent company files for bankruptcy, the holdings in the SPV are protected. In fact, SPVs are often referred to as “bankruptcy-remote entities” because their existence is solely for the purpose of acquiring and financing assets and projects.
The reverse is also true. Just as an SPV can protect certain assets from parent company bankruptcy, if your organization wants to pursue a risky venture you can set up an SPV for that specific activity. Since the SPV is a completely separate legal entity, the parent company mitigates the risk of its own involvement in the venture.
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Other Benefits
In addition to allowing you to spread risk, SPVs provide several other benefits. You can use SPVs specifically to raise capital. Since the SPV’s collateral is evaluated independently it will have its own credit quality and may be able to raise money with better borrowing rates.
You are also able to use an SPV for the transfer of assets. Some assets may be difficult to transfer on their own but by transferring them to an SPV, you may be able to sell the SPV itself.
Overall, establishing an SPV independent of your business will allow you to hedge your losses, either by protecting certain assets in the SPV from any market downturns that may be affecting your overall business or by hiding certain toxic assets from your balance sheet.
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Structuring a New SPV
You can set a Special Purpose Vehicle up as any type of entity, but the most common is a limited liability corporation (LLC) or limited partnership (LP). To create the SPV, the parent company will typically sell assets to the new entity. The SPV then raises the capital to purchase those assets through debt financing by independent investors. One of the requirements for establishing an SPV is that an independent third-party investor owns at least 3% of the debt, assets, and equity.
As the investors purchase ownership in the SPV, the cash is passed back to your parent company and the assets are sold to the SPV. The SPV will typically group the assets into tranches, or securities, that are divided into smaller portions for sale to investors.
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Knowing the Risks
Due to their ability to keep assets separate from the parent company, misuse of SPVs can be dangerous. In fact, SPVs contributed to the downfall of Enron in 2001 and the mortgage crisis of 2008. Enron used SPVs to hide their debt and worthless assets from investors. Alternatively, leading up to the mortgage crisis, banks used SPVs to issue bonds that were secured by mortgages.
While these are extreme examples of improper use, SPVs still present a moderate amount of risk, especially to smaller businesses. The biggest risk is passed to the investors because they do not have a direct individual right to the startup.
Creating an SPV also incurs additional costs and legal requirements. Especially after Enron, accounting standards for SPVs have increased. You may consider enlisting the help of an advisory organization to evaluate the costs and the benefits.
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Creating Your SPV
While an SPV that underperforms will not affect your balance sheet, they could damage your reputation. As with any potential investment or expansion of your business, it is important to carefully weigh the pros and cons. If your organization is looking to take on a new, risky project, consider using an SPV to protect yourself and maximize the investment potential.
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Tarah Mills has always had a passion for writing. Her philosophy is that not only can writing be educational, but it can change the world. While she is dedicated to her work, she still enjoys a good game of basketball, curling up to a good book, and all things Star Wars. She currently resides in the Richmond, Virginia area with her family.
