What is a 'Special Purpose Vehicle/Entity - SPV/SPE'
A special purpose vehicle/entity (SPV/SPE) is a subsidiary company with an asset/liability structure and legal status that makes its obligations secure even if the parent company goes bankrupt. An SPV/SPE is also a subsidiary corporation designed to serve as a counterparty for swaps and other credit sensitive derivative instruments. Although the SPVs/SPEs are used to isolate financial risk, due to accounting loopholes, these vehicles may become a financially devastating way for CFOs to hide debt, as with the Enron bankruptcy.
BREAKING DOWN 'Special Purpose Vehicle/Entity - SPV/SPE'SPVs/SPEs may be formed through limited partnerships, trusts, corporations, limited liability corporations or other entities. An SPV/SPE may be designed for independent ownership, management and funding of a company; as protection of a project from operational or insolvency issues; or for creating a synthetic lease that is expensed on the company’s income statement rather than recorded as a liability on the balance sheet. They help companies securitize assets, create joint ventures, isolate corporate assets or perform other financial transactions.
An off-balance-sheet SPV/SPE documents its assets, liabilities and equity on its own balance sheet rather than on the parent company’s balance sheet as equity or debt. The parent company typically prefers this arrangement due to improved management of assets and liabilities, lower risks, higher credit ratings, lower funding costs, greater financial flexibility and lower capital requirements.
SPV's/SPE's mask crucial information from investors who are not aware of a company’s complete financial situation. Investors need to look at the parent company’s balance sheet as well as the SPV’s/SPE’s balance sheet before deciding whether to invest in a business. Enron’s massive financial collapse is a prime example of why this is important.
Enron transferred much of its quickly rising stock to an SPV/SPE and received cash or a note in return. The SPV/SPE used the stock for hedging assets shown on the company’s balance sheet. Enron guaranteed the SPVs/SPE's value as a means of reducing risk. When stock prices began dropping, along with the values of the SPVs/SPEs, the guarantees were forced into play. Enron was unable to pay the large amounts of money it owed creditors and investors, leading to a massive financial collapse.
Although the company disclosed its financial information and conflicts of interest on balance sheets for the company and for the SPVs/SPEs, few investors understood the gravity of the situation and what ended up being a disastrous ending for Enron.
Example of an SPV/SPE
In March 2016, Luxor Capital, a $3.8 billion hedge fund, announced it was placing four illiquid securities totaling 12% of its investments in an SPV/SPE. The securities included exposure in food delivery service Delivery Hero, private equity investments in online food ordering company Foodpanda and drilling company Ascent Resources, as well as preferred stock in Altisource Asset Management. After losing money for months, the fund began returning 88% of exiting investors’ money. The rest will be returned when the illiquid investments are sold.