The SPV Structure in Infrastructure Finance

The Special Purpose Vehicle (SPV) or Special Purpose Entity (SPE) is one of the most used tools in infrastructure financing. It doesn’t matter whether the project is being constructed by a private company, a public entity, or in a public-private partnership. In most cases, special purpose vehicles are created for every infrastructure project.

In this article, we will understand what a Special Purpose Vehicle (SPV) is and also how a web of contracts is created in order to operate a business through the Special Purpose Vehicle (SPV) structure. The details have been mentioned in this article.

What is a Special Purpose Vehicle (SPV)?

A Special Purpose Vehicle (SPV) is an entity created only for the purpose of execution of the project. This means that for legal purposes, the Special Purpose Vehicle (SPV) is different from the private company or the government body, which may be sponsoring it.

A Special Purpose Vehicle (SPV) has its own balance sheet and profit and loss statement. Lenders are supposed to lend to these Special Purpose Vehicles (SPV) based on their assets and liabilities and not the assets and liabilities of the parent firm. In most cases, the Special Purpose Vehicle (SPV) company takes non-recourse financing. This means that in the event of a default, investors can only seize the assets of the project and not the assets of the parent firm, which may be involved in the project.

As can be seen from the definition, the Special Purpose Vehicle (SPV) is a good mechanism to segregate the risks. The SPV mechanism makes it possible for each project to obtain finance based on its own risk. The existing debt of the company backing the project does not make financing more expensive for a project since the company’s finances are usually not that relevant.

The Different Parties Involved In a Special Purpose Vehicle Structure?

Equity Investors: For the Special Purpose Vehicle (SPV) to come into existence, it has to receive some capital. This capital is provided by the equity investors. Generally, equity investors include private parties and the government. In the case of public-private partnerships, it could be both. This is the primary party that will gain or lose depending upon the performance of the contract. Since they own the equity of the SPV, they control its actions and who it gets into a contract with.

The fact that the investors have to put in money in the Special Purpose Vehicle (SPV) does not make the Special Purpose Vehicle (SPV) structure redundant. The benefit of using the structure is that the equity investors have limited exposure to the downside. The maximum loss that they could face is limited to the amount they apportioned as an equity investment to the Special Purpose Vehicle (SPV).

Debt Investors: Infrastructure projects usually require a huge amount of money. As a result, equity investors are not able to fund the entire project. Also, since the cash flows of the project are somewhat stable, and the returns provided are low, equity investors use a lot of leverage in order to magnify their returns. It is common for infrastructure projects to use a leverage ratio of 10 to 1. Debt investors include banks, investment banks, private equity firms, and even pension funds. Infrastructure companies have been providing a wide variety of financial instruments that the debt investors are using to invest their money in these Special Purpose Vehicles (SPV).

External Agencies: Since Special Purpose Vehicles (SPV) use a lot of borrowed money, they frequently require the help of third-party companies. The Special Purpose Vehicles (SPV) have to engage rating agencies to rate their debt instruments. This is important since many mutual funds and pension funds cannot invest their money in assets that are not above a certain investment grade. Also, the Special Purpose Vehicles (SPV) have to engage financial institutions like banks or insurance companies that provide bank guarantees to investors.

Construction Contractor: Finally, in most cases, the Special Purpose Vehicles (SPV) appoints its parent company as the chief construction contractor. Using this mechanism, the equity investors are able to plow back most of the funds that they had invested in as equity capital. However, they are only able to do so once they execute the projects. Debt covenants usually do not allow the SPV to give out money to the contractor until certain milestones have been met. However, using the SPV structure, the company is able to execute the projects without taking any undue risks.

Maintenance Contractor: Lastly, once the project is constructed, it is usually given out to a maintenance contractor. This contractor is generally another SPV which has the same set of stakeholders and follows more or less the same process. Even if the same parent company plans to maintain the project, they generally create a different SPV. In this case, the SPV is done to safeguard the revenues. The idea is to protect these risk-free revenues by segregating them from other risky investments which the company may be undertaking.

The bottom line is that the Special Purpose Vehicle (SPV) structure is at the heart of infrastructure financing. It allows the equity investors to segregate revenues and protect them from risks that may be arising in other projects.