Special Purpose Entity (SPE)

Special Purpose Entity Definition

It’s a separate legal entity created to fulfill certain objectives which may include devising measures to appropriate financial risk and/or legal risk profile, this entity generally has a predefined purpose and have a limited scope in terms of activity and sometimes used as a short term solution to a current or potential problem also their structure is accordingly devised.

It is also sometimes called as the special purpose vehicle. Generally, the SPE is the subsidiaries of the larger corporation with the different liability structure, asset structure and the legal status which makes all its obligations secure. It is secure even if its parent company becomes bankrupt. It is also designed for serving as the counterparty for the swaps and the other type of derivative instruments which are credit-sensitive.

Although Special Purpose Vehicle is used for isolating the financial riskThe Financial RiskFinancial risk refers to the risk of losing funds and assets with the possibility of not being able to pay off the debt taken from creditors, banks and financial institutions. A firm may face this due to incompetent business decisions and practices, eventually leading to bankruptcy.read more present because of the different accounting loopholes, at the same time these entities may become CFO’s financially devastating way for hiding the debts.

SPE

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Types of Special Purpose Entity (SPE)

The following are the 2 types of SPE.

#1 – On Balance Sheet SPE

In the case of on Balance Sheet SPE, the financial results of the Special-purpose entity are consolidated with the parent company’s financial results. The incomes in this case by some means are transferred to the parent company.

#2 – Off-Balance Sheet SPE

In the case of off Balance Sheet SPE, the financial results of the Special-purpose entity are not consolidated with the parent company’s financial results and the incomes are also not transferred to the parent company by any means.

Example of the Special Purpose Entity (SPE)

There is a company named BCF limited which is famous for manufacturing the different types of equipment used for industrial purposes. The company uses a special purpose entity for financial risk leverageFinancial Risk LeverageFinancial Leverage Ratio measures the impact of debt on the Company’s overall profitability. Moreover, high & low ratio implies high & low fixed business investment cost, respectively. read more. Out of all the Special-purpose entity’s of the company, one of the SPE has independent members on the board which consists of a commercial bank which provides the credit facilityCredit FacilityCredit Facility is a pre-approved bank loan facility to businesses allowing them to borrow the capital amount as & when needed for their long-term/short-term requirements without having to re-apply for a loan each time. read more and the loan, different equity investors who have the tax free investments, government who provides the subsidies and also permits the company for the operation of the contracts of the Special-purpose entity, and the sponsor protecting the minority investors of the parent company and coverage to the technical risk.

The SPE Company formed acts as the equipment solution provider and other technical consulting issues. Also, the Special-purpose entity (SPE) offers construction engineering and maintenance.

The different advantages which the parent company BCF limited have when its BCF limited is operating involves the high-level project and risk management which allows the company in collaborating with its stakeholders and the chain holders effectively. Apart from this, it is easy for the parent company to finance its operations using government funding, long-term debt or equity investors without any compromise to its main operations.

Advantages

  • By the creation of the Special purpose vehicle, the parent company will be allowed to isolate the financial risk legally which is associated with the project and share it with the other investors.
  • SPE helps in the tax saving for the company in case the entity is created in the tax haven countries.
  • It is easy to set up the SPE.
  • The Special purpose vehicle and the parent company are not bound with the same rules and regulations, so it offers more freedom to operate Special purpose vehicle
  • SPE helps in keeping secrecy with respect to some projects from the competitors of a parent company or from the investors of the parent company whose company thinks may disapprove of the particular transaction.
  • There is direct ownership in case of the Special-purpose entity of the specific asset
  • The parent company can perform the high-risk transactions using the Special-purpose entity without endangering the solvency of the entire company.

Disadvantages

Important Points to be Noted

Conclusion

Thus the Special-purpose entity (SPV) is the subsidiary company that is formed with the purpose of facilitating financial arrangements of the parent company which includes the speculative investments and leverage, without compromising the whole group.

This means that in case the Special purpose vehicle becomes bankrupt then in that case also the parent company remains unaffected and in case the parent company becomes bankrupt then the Special-purpose entity remains protected and unaffected. Special purpose entities generally are used for the purpose of securitization and they are allowed to buy, sell and finance the assets.

Recommended Articles

This has been a guide to a Special Purpose Entity (SPE) and its definition. Here we discuss the top 2 types of SPEs along with examples, advantages, and disadvantages. You can learn more about financing from the following articles –

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