Finance education – Page 24

What is SPV? A Special Purpose Vehicle (SPV) or Special Purpose Entity (SPE) is a separate company, entitled as a subsidiary, created to separate the financial risks from its parent company. The legal status of an SPV is independent of its parent company to prevent any negative impact on it if the parent company faces financial issues. An SPV maintains its own separate balance sheet, which allows it to carry the negative impact that may occur on the parent company and the investors by undertaking ventures with higher risks. Another reason behind keeping an SPV off the parent company’s balance sheet is to secure the assets with a separate legal entity. SPV can also become a source of securitizing company debts. This will help in maintaining the investor’s faith in the parent company. Why are SPVs Used? SPVs are used either to undertake all the risky projects to protect the parent company from such risks or to protect the parent company's assets. In any case, its primary purpose is to separate the financial risks of activities performed by the parent company. An SPV is a separate legal entity from its parent company. It maintains separate financial records and balance sheets. This allows the parent company to isolate the financial risks from its activities. Although the role of an SPV is specified, its common use is to have separate structured finance. The purpose of an SPV may include; undertaking joint ventures or property deals on behalf of the parent company or securitization of assets by isolating them from the potential risks and its operations. Not just assets, SPVs also aim at securitizing debts, keeping the investors assured about their earnings. How to Set Up an SPV? There are many ways a parent company can form an SPV. It may be formed as a trust, a limited liability partnership or corporation, and others. There are two main conditions that need to be completed to create an SPV. One is that independent and separate management is to be created, and second, an equity investment must be made by one of the parent company owners. The investment should not be less than 3% of the assets of the SPV. What Is the Function of SPVs in Public-Private Partnerships? In a public-private partnership, an SPV formation is generally the requirement set by the private company owners. The primary aim of an SPV in a public-private partnership is to reduce the financial exposure of private company owners, especially in the case of capital-intensive projects. A public-private partnership is a partnership between private companies and government agencies. Such alliances are formed to build or finance large-scale projects, like hospitals, schools, bridges, or roads. Such projects involve significant investments, both technological and financial. These investments have risks involved, and an SPV helps in absorbing a part of, if not the entire, such risks. Does an SPV Pay Capital Gains Tax? Capital Gain Tax is paid by an SPV if there is a transfer of assets. However, the rate of tax is generally lower. If there is a transfer of property, there is generally a difference between the buying price and the selling price. If the buying price of that asset is lower than the selling price, it results in capital gains, and therefore, it is subject to capital gain tax. SPVs also have to pay capital gain tax if there is a transfer of an asset at a profit. Like an individual taxpayer, it may not get any capital gain allowance. How Do I Finance an SPV? An SPV gets most funds from the capital market and individual investors. An SPV is created to raise funds for the parent company, undertake high-risk projects, and hold assets. These assets are pooled, then converted into trenches, and sold to potential investors according to the credit risk preferences of the parent company owners (investors). Can an SPV be a Holding Company? As an SPV rarely engages in active operations, like manufacturing, and is most likely to hold assets of its parent company, it can be a holding company. In many cases, an SPV is used to hold the assets or investments of its parent company. There could be a single asset or a portfolio of investments that an SPV holds. There are many benefits of making an SPV a Holding Company. As they can be formed quickly, raising funds through a holding company can be done by issuing tradable assets, stocks, or debts in the open market. Separating SPV as a holding company from its parent company helps in the better management of assets. What are the Advantages and Disadvantages of an SPV? The benefits of an SPV involve securitizing its assets and isolating the risks of a parent company. There are possible drawbacks associated with creating an SPV, like it restricts the parent company’s capacity to borrow funds. Apart from securitization, an SPV provides easy access to the capital markets. Bonds that the SPV securitizes have a lower rate of interest than the traditional ones. Along with safeguarding the assets, it also protects the shareholders from credit risk if a parent company faces financial risks. It is easy and convenient to create if the company follows all the regulatory norms and can get tax benefits if created in a country considered a tax haven. One major drawback of SPV, which has been seen in the case of Enron, is that it can be misused to manipulate investors. It may cost a lot to the parent company if it decides to transfer assets from the SPV to the parent company. An SPV may not be able to raise funds quickly, even though it has easy access to capital markets, because it may not have a good reputation like its parent company, as it is a separate identity. Can an SPV be a Subsidiary? Yes, an SPV is a subsidiary of the main or the parent company. As the parent company owns it, and all its activities are controlled, and in the interest of the main business, an SPV is more or less a subsidiary. It is created to help the parent company get some financial benefits, isolate risks and securitize assets and debts. As a subsidiary, an SPV is a separate legal entity from its parent company, with separate balance sheets, liabilities, and assets. All these, and other features, make it a subsidiary.