What is an SPV and Should Your Business Have One?

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Also known as a special purpose entity, a special purpose vehicle is a legal entity created to serve a special purpose independent from the parent company. An SPV is a fully operational company and has to follow all the rules stipulated in the Company’s Act. The members of the SPV are companies, organizations, or individuals sponsoring the entity. A company that starts an SPV can be said to be a general purpose vehicle. This company can carry out everything in the Memorandum of Association (MoA) and follow the rules in the Companies Act. While an SPV can still do the same, its scope of operation is narrow.

Why Do Companies Start SPVs?

Start by researching, “What is an SPV and how can it benefit my business?” This will lead you into discovering that when a company starts an SPV, it starts it as a separate entity. The SPV comes with its own assets, liabilities, and an independent legal status. Usually, companies start SPVs to mitigate risks by expanding the company to a separate entity to share the risks. The separate entity provides opportunities to company investors who would otherwise not be available to invest in the parent company.

Mitigate Risks

The parent company sets aside an underlying pool of assets that offers a host of benefits to investors. It is an easy way for the parent company to raise capital without increasing the debt burden. Investors and the originator have the assurance that if the parent company ever goes bankrupt, the SPV will be standing to fulfill the goals of the originator. In the same way, if the SPV is bankrupt, the main company will not be affected.

The arrangement works for companies that engage in sophisticated and time-sensitive projects. For instance, a developer might use an SPV when handling a complicated project to avoid endangering the parent company. Going the procurement route exposes the developer to certain risks that they can avoid by using an SPV.

SPVs are not Liabilities on the Balance Sheet

SPVs do not appear on the balance sheet as liabilities. Some companies have used SPVs in a wrong way under this subject. For instance, Enron hid his company’s debts in SPVs, so investors felt it was safe to invest when it was not. The off-balance sheet treatment benefits your company as you can use the phenomenon for your tax and financial reporting.

The only challenge with an SPV is in its closing after a project. Moving the assets from the SPV to the parent company can involve some cost. However, if the parent company decides to sell the assets, their balance sheet might suffer. Companies need to understand the process of formation of an SPV in detail and work with professionals (including lawyers) to make the process smooth. Creating the SPV the right way helps companies avoid credibility and liquidity issues and issues on finance raising capacity.

Attract Investment

When a parent company starts a brand new company as a separate entity, the parent company gets so many benefits. There is no liability or baggage attached to the parent company. Once you start an SPV, you give lenders and investors an opportunity to invest their money. It is easy for an investor or lender to understand an SPV, seeing that it only has a single purpose, or only serves a single project. The underwriting process is simple and straightforward with an SPV unlike in a limited company where the process is lengthy. Lenders do not need to go through stress, and the lending process is not as rigorous as in the parent company.

The assets of the SPV can be used as collateral. However, lenders might check the collateral against the credit quality of the originator, and this can lead to low funding costs. Once the SPV serves its special purpose, it can be closed and the built assets sold. The parent company can always start another SPV when another project comes along.

Conclusion

Companies looking to start an SPV must observe due good governance. The SPV might be guided by a set of rules, procedures, and processes. There should be a framework that shows how the company is governed. Leaders need to engage in a detailed due diligence to ensure they consider all the aspects of starting an SPV. This way, the company will not make a loss of starting an SPV under illegal grounds.