What is a Special Purpose Vehicle/Entity - SPV/SPE
A special purpose vehicle/entity is a "bankruptcy-remote entity" that a parent company uses to isolate or securitize assets and it often holds these off-balance sheet. Some also call this a "bankruptcy-remote entity" or "variable interest entities" since its operations are limited to the acquisition and financing of specific assets as a method of isolating risk. A special purpose vehicle/entity 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 company uses SPVs/SPEs 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.
Special Purpose Entity/Vehicle
BREAKING DOWN Special Purpose Vehicle/Entity - SPV/SPE
A company may form SPVs/SPEs 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 the company expenses on its income statement rather than recorded as a liability on the balance sheet. SPVs/SPEs 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 asset and liability management, lower risks, higher credit ratings, lower funding costs, greater financial flexibility and lower capital requirements.
Special purpose vehicles/entities mask crucial information from investors who may not be aware of a company’s complete financial situation. Investors need to analyze the balance sheet of the parent company and SPV/SPE before deciding whether to invest in a business. Enron’s massive financial collapse is a prime example of how a lack of careful balance sheet analysis can hurt investors.
Enron transferred much of its quickly rising stock to a special purpose vehicle/entity and received cash or a note in return. The special purpose vehicle/entity then used the stock for hedging assets held on the company’s balance sheet. To reduce risk, Enron guaranteed the special purpose vehicle's/entity's value. When Enron's stock price dropped, the values of the special purpose vehicles/entities followed, and the guarantees were forced into play. Enron could not 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 the special purpose vehicles/entities, few investors understood the gravity of the situation and what ended up being a disastrous ending for Enron.