What is a Special Purpose Vehicle or Special Purpose Entity?

A Special Purpose Vehicle or Special Purpose Entity (SPV/SPE) is a corporate entity created by a parent company to carry out specific transactions or business different from that of the parent company. Parent companies establish SPVs to fulfill specific objectives such as protection against financial risk. An SPV/SPE Is a subsidiary company but has a legal structure and owns assets that isolate it from the financial risks of the parent company. An SPV is secured even if the parent company faces huge liabilities and financial risks. Parent companies establish SPVs for a predefined purpose such as protecting it from bankruptcy and insolvency.

How does a Special Purpose Entity Work? 

A special-purpose vehicle or entity is often created as a way of isolating risks that the parent company might face. Usually, SPVs are legal companies created by a parent company, their operations, businesses, and transactions are often distinct from those of the parent company.   

SPVs or SPEs can be created as corporate entities, trusts, limited partnerships, limited liability corporations, and others. These entities have assets, liabilities, and legal status outside of the parent company. They also run their business operations separate from the parent company. Parent companies often establish SPVs as a form of protection against insolvency and financial issues.

Off-Balance-Sheet SPV/SPE

An off-balance-sheet SPV/SPE is an SPV that its own separate balance sheet where it records its equity, assets, and liabilities. Some SPVs share the same balance sheet with the parent company and have their equity, assets, and liabilities recorded on the parent's balance sheet. 

However, off-balance-sheet SPVs are more common, with this strategy, a parent company can effectively lower its risks, and have enhanced liability management and more flexible financial structure. Investors that want to invest in SPVs need to carry out a detailed analysis both on the balance sheet of the parent company and of the SPV.

Enrons SPVs/SPEs

Enron is a good example of a parent company that created a special-purpose vehicle or entity for protection purposes and isolation of risks. When Enron created its SPV, all its fast increasing stock was transferred to the SPV. However, the value of Enrons SPV was backed /guaranteed by Enron. This was why when there was a fall in Enrons stock price, the SPV/SPE's value also declined which led to the major crisis that rocked Enron.