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CT Expert Insights: The Importance of a Special Purpose Entity / Vehicle for Your Structured Finance Deal

A special purpose entity (SPE) or vehicle (SPV) is a unique entity or means of holding on to an asset in a place separate from the rest of your business. While they are common in real estate, many businesses find them advantageous to use in any kind of large lending situation. Ian Bone, Senior Manager of Strategy and Innovation at CT Corporation, discusses what SPVs and SPEs are, when to use them, and the benefits and risks associated with them. 

 

TRANSCRIPT

Greg: Hi, I’m Greg Corombos. Our guest this week is Ian Bone. He is the Senior Manager of Strategy and Innovation at CT Corporation. Our topic today—the value of a special purpose entity or vehicle for your structured financial deal. Ian, thanks very much for being with us.

Ian: Thanks for having.

Greg: Let’s start with the very basics. What is a special purpose entity or vehicle?

Ian: One of the things to get out there right away is that if you hear SPE or SPV, SPE being a special purpose entity or SPV being a special purpose vehicle—more or less the same thing. Kind of the difference between Argentine and Argentinian. It means the same thing, but it’s a slightly different way of saying it. Basically, they are unique entities or means of holding onto an asset in a separate place from the rest of your business or any other legal entity structure you might have. It’s like an island for something special.

Greg: What is a typical SPE or SPV structure?

Ian: Generally you’ll see, if you have a corporation you’re setting up, which will have complex structures of ownership and things like that, an SPV will be separate [and] to the side. It may be part of a holding company or some other broader organization that it ties into. But it’s something that’s tethered alongside and sitting kind of by itself. Not necessarily where you have a lot of different things pooled together, but it’s an individual entity that’s linked to some other area, but in a way that it’s able to maintain its own existence separate from whatever it’s owned by.

Greg: Ian, what would be an obvious or likely situation that you would want an SPE or SPV?

Ian: SPVs are used all the time for real estate transactions, but really any kind of large lending situation—you might want to have something like this. Anything where you want to set aside liability and risk into itself. You see this with securitization of loans, things where you want to be transferring a specific asset. So if you’re looking at selling one building—say you own a big office complex, and there are four different buildings and you just want to sell one of them. They might have been owned all together previously or through some other structure previously. You’ll have a special entity that one thing you’re selling will get put into to transfer that asset out of your holdings. You could do it for specific regulator reasons around if you have some financial elements—like regulations recently around banks and things like that have been heightened. You may not want to have all of your business considered to be a bank or something that have a higher regulatory hurdle, so you may put those assets and operations into a special purpose vehicle.

The main place we see it is around property and large lending scenarios, usually some kind of real property. Mind you, real property can be a lot of different things to the IRS. But I’ve heard all kinds of great things about how trees themselves are property separate from the land that they’re on. So you may have two separate SPEs for timberland—one for the land and one for the trees. But different kinds of property and machinery and things like that are where you will see these special purpose entities used.

Greg: There may be some folks that might be thinking that there are so many different aspects to an agreement I’m working on. Why should you do this to complete a deal?

Ian: I’m not a lawyer. This is not any kind of legal advice. So definitely talk to your lawyer or tax professional about this to understand when to use this. They know that 100% better for your scenario. But whenever you’re looking at how to put a fence around something or to protect something or protect yourself from something that’s really risky. In terms of a business scenario, if you would be putting on gloves before touching that kind of business or operations, that is what an SPV helps you do. You can think of them as being your safety gloves to make sure that any sort of risk associated with the business doesn't leak into the rest of what you do.

Or, alternatively, if everything else that you do is perhaps riskier or more volatile that you might want to protect something like your intellectual property inside this special purpose vehicle so that it doesn’t get harmed or taxed the same way as everything else that you do.

Greg: let’s get into the nuts and bolts now. Let’s talk about the features and benefits of an SPV or SPE. Let’s talk about the good parts first.

Ian: the good part is how much it protects you. Say you have a special purpose entity for a specific property that you own separate from all the other elements of your business. Say it’s a factory and somebody—God forbid—get’s hurt, or wants to sue you for whatever reason about something that happened on premise. Maybe it’s not a work-related accident, but something happened there. They broke in and tripped and fell, and now they want to sue you. Well, they can sue you for the value of that asset, because that’s what they were in. But they can’t go after your entire business—or it would be more difficult. I won’t say they can’t. Lawyers always find ways to do things. But it helps insulate some of the things there.

Also, we’ve seen this—this may be a bit of the bad-guy scenario as well on the reputation side, which we’ll get to a little bit later—people hear all about how Apple or Google have all of their intellectual property sitting in an offshore jurisdiction that they get taxed lower in. Whether or not that is something they *should* be doing, it’s something that they can do and is legally allowed, and they’re taking advantage of these SPVs and these structures to take something like their intellectual property, which is used globally, and put it into a location with different regulations, different laws, different taxes, so that all the money they make licensing out their intellectual property to their own other businesses or to other outside businesses is held in a jurisdiction that’s more financially beneficial. There’s a lot of financial structuring that can be done and financial engineering to make sure you’re reaching the best return on all of your investments.

Greg: Those are the upsides. Let’s talk about downsides. What are the big risks potentially involved with SPEs and SPVs?

Ian: The biggest one is the reputational risk, which I mentioned. The last thing you want is to be front-page of the WSJ about how you’re taking advantage of this weird thing that people don’t understand. And I think it’s one of the biggest issues here. A lot of times, people don’t understand it—it seems like this special thing, right? It’s a special purpose vehicle. But it seems weird and not everyone is using, so they don’t understand. There’s always the possibility that it may seem that you’re doing something less than above-board, even if it’s totally fine. So the reputational risk is sometimes different. A lot of things you’ll read about this—that they’re ways of people hiding things, hiding ownership—and in some cases that’s exactly what people are doing.

But sometimes people—I think—it’s for the right reasons. If you’re Jennifer Lopez and you’re buying an apartment in New York, you’re probably going to get a different price as Jennifer Lopez than as 123 LLC, as special purpose vehicle for buying her apartment. Wealth managers will use these things to make sure you’re not being taken advantage of because people think that you have extra money, or people find out where you live just because you bought something, things like that. But because it’s used to legitimately help people hide sometimes, it can also be a point where people are a little bit wary about it, that it is thought of a way of hiding assets or putting assets aside. It’s an area where we could see more scrutiny in the future, especially as people look into more stringency around money laundering and potential ways that terrorists move money around. Obviously, the U.S. government has been doing a great job of tracking all of that and freezing improperly moved assets. But it puts you in a position where you have to be doing everything for the right reasons, and you can explain why you did it. Otherwise, it could look bad. It’s an optical problem more than a physical problem usually.

Greg: Last question for you, Ian. Obviously going into this situation, you want to be assure that you’ve thought of everything. And in most cases, you are convinced of that. What’s a good way to make sure you have thought of everything before you enter into this?

Ian: I would say talk to the professionals in your business life. Make sure that they’re actually knowledgeable about that specific item. It could be going to your attorney or to your tax advisor. But sometimes a general CPA or general business attorney may not have the experience. You may want to talk to someone who regularly sets these up, whether it’s a real estate attorney if it’s about a property instead of just your regular business counsel, trust, and estates lawyer—they do a lot of these kinds of things, if it’s for something personal instead of wealth planners, things like that. Going to experts who know what they’re doing, and understanding the things that come with it. There are a lot of additional steps that you have to sometimes involve, whether it’s appointing independent directors, having other kinds of oversight, and legal steps that you need to do to protect yourself and the financial counterparties in these SPVs.

 

 

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