A special purpose entity (or a special purpose vehicle) is a legal entity that has been established to separate an asset, subsidiary, or financial transaction from a larger corporation or government agency. 

A special purpose vehicle (SPV) is typically created for a limited task to help isolate risk with a transaction or an asset. For example, an SPV might be established for a subsidiary of a larger corporation. The balance sheet of the SPV is separate from the larger entity, which can help to track income, expenses, and debt for the SPV. A special purpose entity can also be established for joint ventures, such as a public-private partnership (PPP).

Key Takeaways

  • Special purpose vehicles are legal entities that separate a financial arrangement or project from a larger corporation or government entity. 
  • Public-private partnerships are collaborations between a government agency and a privately owned company.
  • An SPV can help local governments complete projects sooner since the private company may have resources needed to complete the project.
  • Since financing infrastructure projects can be costly, a partnership allows the private company to share in the costs and revenue.

How a Special Purpose Vehicle Works

Since special purpose vehicles function as subsidiary entities for larger parent organizations, they're typically used to finance new operations at favorable terms. The SPV can raise capital without carrying the debt or other liabilities of the parent organization even though the subsidiary is often operated by the same individuals and serves purposes that benefit the parent organization.

Although SPVs can have their own employees and carry out tangible business operations, the entities are first and foremost an off-balance-sheet tool. The off-balance sheet status means that companies can change the SPV's overall framework of asset and liabilities without those changes carrying over to the financial statements of the primary company.

The SPV allows for improved financing and a greater degree of operational control for the private agent. Since every SPV can vary based on its founding legal and financial agreements, its specific role is often unique to the partnership between the parent company or other entity.

Public-Private Partnerships

A public-private partnership is a contractual arrangement or collaboration between a public or government agency and a privately owned company. Public-private partnerships are formed to help with large public projects, such as infrastructure, public transportation, convention centers, and parks. 

A public-private partnership can help a local government complete a project sooner since the private company might have equipment and resources needed to complete the project. Also, financing infrastructure projects can be costly, and a partnership allows the private company to share in the costs, which can help the government save money. Oftentimes, a private company can be more cost-efficient and effective at delivering the necessary products and services. In return, the private company earns income from the government or a share of the revenue generated from the project.

Benefits of SPVs in a Private-Public Partnership

Many private partners in a public-private partnerships demand a special purpose vehicle as part of the arrangement. This is especially true for capital-intensive endeavors, such as an infrastructure project. The private company might not want to take on too much financial exposure, so an SPV is created to absorb some of the risks.

There isn't a uniform operational role or legal design for the use of SPVs in a PPP; the particulars vary depending on the agreements of the actors and stakeholders in the project. However, every SPV needs to be created in accordance with the proper legal and accountancy rules in the jurisdiction.

SPVs and Default Risk

Most public projects rely on support from commercial banks or other financial institutions. Typically, the SPV represents the financing wing and is used to attract funds from other lenders and investors. This arrangement protects the government agency and all financing parties from immediate counterparty risk. In the case of non-recourse financing, the lender's only valid claims are limited to project assets in the case of non-completion or default, which is non-payment of the loan.

SPVs and Financial Flexibility

In turn, the SPV's balance sheet or financial transactions do not impact the balance sheets of the private company nor the government agency. As a result, the government agency is able to keep the project's debt and liabilities off its own balance sheet, which leaves more fiscal space for other public obligations.

The additional fiscal spending capacity can help lead to higher government bond credit ratings. Government bonds are debt securities that are issued to raise funds for projects and investments. All bonds have an assigned credit rating that is issued by credit rating agencies, such as Standard & Poor's (S&P). The ratings are a numerical value representing the likelihood of default by the government issuing the bond. Typically, government bonds are considered low-risk investments since they're backed or guaranteed by the government.

The SPV in a public-private partnership can help a government maintain financial and fiscal flexibility allowing it to issue bonds if needed for other projects. Also, a better credit rating can lead to a lower interest rate on any outstanding bonds, which can help governments keep their expenses or debt-servicing costs low.