Special Purpose Entity Meaning Example Top 2 Types Of Spe

Special Purpose Entity Meaning

It is also sometimes called a special purpose vehicleSpecial Purpose VehicleA Special Purpose Vehicle (SPV) is a separate legal entity created by a company for a single, well-defined, and specific lawful purpose. It also serves as the main parent company’s bankruptcy-remote and has its own assets and liabilities.read more. Generally, the SPE is the subsidiary of the larger corporation with different liability structures, asset structures, and legal status, which makes all its obligations secure. It is secure even if its parent company becomes bankrupt. It is also designed to serve as the counterpartyCounterpartyA counterparty in a financial transaction is the person or entity on the other side of the agreement. Any trade must have at least two parties who serve as counterparties for each other. For every buyer in a purchasing deal, there must be a seller. And for every seller, there must be a buyer willing to purchase.read more for the swapsSwapsSwaps in finance involve a contract between two or more parties that involves exchanging cash flows based on a predetermined notional principal amount, including interest rate swaps, the exchange of floating rate interest with a fixed rate of interest.read more and the other types of derivative instruments that 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.

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Types of Special Purpose Entity (SPE)

The following are the two types of SPE.

#1 – On Balance Sheet SPE

In the case of 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 entities of the company, one of the SPE has independent members on the board, which consists of a commercial bank that provides theCredit 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 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 to collaborate with its stakeholdersStakeholdersA stakeholder in business refers to anyone, including a person, group, organization, government, or any other entity with a direct or indirect interest in its operations, actions, and outcomes.read more and the chain holders effectively. Apart from this, it is easy for the parent company to finance its operations using government funding, long-term debtLong-term DebtLong-term debt is the debt taken by the company that gets due or is payable after one year on the date of the balance sheet. It is recorded on the liabilities side of the company’s balance sheet as the non-current liability.read more or equity investors without any compromise to its main operations.

Advantages

Disadvantages

It requires a substantial amount of capital for creating the Special-purpose entity.The SPE has lower access to the capital when compared with the parent company because the Special-purpose entity doesn’t have the same level of credit as the parent company has.Suppose there are some unexpected changes in the rules and regulations in the market which apply to the particular Special-purpose entity. In that case, it can create a serious problem for the companies using these special purpose entities as they might not be able to meet the new rules and regulations that came into existence.The Accounting rulesAccounting RulesAccounting rules are guidelines to follow for registering daily transactions in the entity book through the double-entry system. Here, every transaction must have at least 2 accounts (same amount), with one being debited & the other being credited. read more of Mark to Market could be triggered if the asset is sold, which will negatively impact the parent company’s balance sheet.There are fewer options available to fund the special purpose vehicle.

Important Points to be Noted

The parent company can form the SPE through trusts, corporations, limited partnershipsLimited PartnershipsIn a limited partnership, two or more individuals form an entity to undertake business activities and share profits. At least one person acts as a general partner against one limited partner who will have limited liability enjoying the benefits of less stringent tax laws.read more, limited liabilityLimited LiabilityLimited liability refers to that legal structure where the owners’ or investors’ personal assets are not at stake. Their accountability for business loss or debt doesn’t exceed their capital investment in the company. It is applicable in partnership firms and limited liability companies.read more corporations, etc.The documentation of the equity, assets, and liabilities is done by the Special-purpose entity (SPE) on a balance sheetBalance SheetA balance sheet is one of the financial statements of a company that presents the shareholders’ equity, liabilities, and assets of the company at a specific point in time. It is based on the accounting equation that states that the sum of the total liabilities and the owner’s capital equals the total assets of the company.read more of its own rather than the parent company’s balance sheet as the equity or debt.SPE may hide crucial information from its investors who might not completely know the company’s financial situation. With this risk, the investors shouldBalance sheet analysis interprets the company’s assets, liabilities and owner’s capital in a certain period. It provides an accurate picture of the organization’s financial health and position to the investors, shareholders and institutions.read more analyze the balance sheetAnalyze The Balance SheetBalance sheet analysis interprets the company’s assets, liabilities and owner’s capital in a certain period. It provides an accurate picture of the organization’s financial health and position to the investors, shareholders and institutions.read more of the Special-purpose entity and the parent company properly before reaching any conclusion regarding investing in the business of any of them.

Conclusion

Thus, the Special-purpose entity (SPV) is the subsidiary company formed to facilitate the parent company’s financial arrangements, which includes speculative investments and leverage, without compromising the whole group.

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