A parent company creates an SPV to isolate or securitize assets in a separate company that is often kept off the balance sheet. It may be created in order to undertake a risky project while protecting the parent company from the most severe risks of its failure.
In other cases, the SPV may be created solely to securitize debt so that investors can be assured of repayment.
In any case, the operations of the SPV are limited to the acquisition and financing of specific assets, and the separate company structure serves as a method of isolating the risks of these activities. An SPV may serve as a counterparty for swaps and other credit-sensitive derivative instruments.
Special Purpose Entity/Vehicle
A company may form the SPV as a limited partnership, a trust, a corporation, or a limited liability corporation, among other options. It may be designed for independent ownership, management, and funding. In any case, SPVs help companies securitize assets, create joint ventures, isolate corporate assets, or perform other financial transactions.
How the SPV Works
The financials of an SPV may not appear on the parent company’s balance sheet as equity or debt. Instead, its assets, liabilities, and equity will be recorded only on its own balance sheet.
An investor should always check the financials of any SPV before investing in a company. Remember Enron!
Thus, the SPV may mask crucial information from investors, who are not getting a full view of a company’s financial situation. Investors need to analyze the balance sheet of the parent company and the SPV before deciding whether to invest in a business.
How Enron Used the SPV
The massive financial collapse in 2001 of Enron Corp., a supposedly booming energy company based in Houston, is a prime example of misuse of an SPV.
Enron’s stock was rising rapidly, and the company transferred much of the stock to a special purpose vehicle, taking cash or a note in return. The special purpose vehicle then used the stock for hedging assets that were held on the company’s balance sheet. To reduce risk, Enron guaranteed the special purpose vehicle’s value. When Enron’s stock price dropped, the values of the special purpose vehicles followed, and the guarantees were forced into play.
Its misuse of SPVs was by no means the only accounting trick perpetrated by Enron, but it may have been the greatest contributor to its abrupt fall. Enron could not pay the huge sums it owed creditors and investors, and financial collapse followed quickly.
Before the end, the company disclosed its financial information on balance sheets for the company and the special purpose vehicles. Its conflicts of interest were there for all to see. However, few investors delved deep enough into the financials to grasp the gravity of the situation.
