The Requirement of Special Purpose Vehicle within a Project - Case Study Example

The Requirement of SPV within a Project Student’s Name: Institution: Date: Table of Contents Introduction 2 Overview of a Special Purpose Vehicle 3 Strengths of a Special Purpose Vehicle 3 Literature Review 4 A Case Study of a Special Purpose Vehicle 5 Financial valuation 5 Commercial Analysis 6 Reasons and Advantages of Using a Special Purpose Vehicle 7 Advantages and Challenges of SPV 7 The Project Financing Process 8 Earned Value Methodology 8 Managing the budget for special purpose vehicle 9 Advantages and pitfalls of project financing 9 Sustainability in the Project 11 Conclusion 12 References 13 Blossom (2015). Understanding the Complexities ofthe Special Purpose Vehicle. Blossom Wealth Management. Retrieved January 27, 2017from http://www.blossomwm.com/understanding-the-complexities-of-the-special-purpose-vehicle/ 13 The Requirement of SPV within a Project Introduction Project management requires efficient and accurate planning so as to meet the needs of the project. There are any projects which fail almost immediately after they start due to poor planning which may lead to inadequate resources. When planning stage is done well, the right amounts of resources are made available and there are higher chances of the project succeeding. A special purpose vehicle project may need a lot of analysis so as to determine the right choice among the available options. In a project management team, the leader should have a clear budget discussed by the rest of the managers so as to have the right financing before the project starts. Sustainability is considered and the earned value methodology can be used to manage the operations. Management control systems, balanced scorecard, and other strategic management skills are used to make sure that the expected results have been achieved. Overview of a Special Purpose Vehicle A special purpose vehicle or special purpose entity is a term used to protect and ensure a smooth flow of subsidiaries in a company. The main reason why the SPV is used is to make sure that the mother company is secure from the adverse occurrences in the subsidiary, for example, in case of a bankruptcy. One of the well-known cases where it had a negative effect is in the case of Enron which collapsed in 2001. Since that time, many countries and companies have discouraged it and fear its repercussions (Blossom, 2015). However, a recent introduction of its use in India has encouraged more people to reconsider its use. Strengths of a Special Purpose Vehicle The powers of the special purpose vehicle usually follow the purpose for which it was created. In a case where the project that was to be managed is cancelled, it fails or completed successfully, then the special purpose entity is terminated immediately. The main strength is that it ensures the intended projects are well funded and will not have financial hiccups. The vehicle is expected to operate independently and it can even have a separate office where the documents of the project are kept and managed. The office holds the data about the shareholders agreement, period of the project, and participants among other details (Blossom, 2015). Managing the separate entity may require an extra team or a part of the existing management team. Literature Review Past research shows that companies may affect the subsidiaries when they go bankrupt. The use of the SVP helps in making sure that the chances are reduced. The opposite is also true in that when the SVP is used, the mother company is left standing even in case the project or subsidiary falls. By transferring assets and funds to the special purpose entity, the business takes care of such adverse cases (Wan & Sidoti, 2016). The legal form adopted can be a limited partnership, a limited liability, or a corporation. Enron, a company that went bankrupt in 2001, is one of the companies which used special purpose vehicles which highly contributed to its failure (Klee & Butler, 2002). There are two different types of balance sheet operations, which are off-balance and on-balance. Enron used many off-balance operations, and there are many cases whereby special purpose vehicles can apply and offer good management tools. The type of the vehicle chosen depends on the nature of the company and the legal options available. The local laws in a country are used to determine the kind of legal procedures to be followed when choosing the special purpose vehicle. The nature of the transactions expected is also a major factor which has to be put in place to determine the best SVP to follow. Tax regimes and financial structures of the company will also be part of the decisions to be made (Ashman, 2000). The power, the authority, and the capacity of the SPV is also dependent on most of the factors listed above, and the nature of the company (Dyke & Jennings, 2012). The limitations used in a special purpose vehicle are usually based on the intended purpose and one of them is the level of credit. The SPV can be restricted on the maximum amount of credit that it can offer. The purpose of this limitation is to reduce the chance of bankruptcy. A Case Study of a Special Purpose Vehicle Financial valuation A family company, which has been dealing with construction and real estate, had been buying property for a long time. The company feels that due to the changing taxing system, the business environment and other factors, there was a need to establish a special purpose vehicle which will be used to buy property in its name. The company leaders approached mortgages experts with an aim of having the idea made a reality. They asked for the best way to establish a SPV, which would take a limited company legal structure. Their concern was also boosted by the relief given by the government on the buy-to-sell business operations. The idea was also meant to secure the company investors who have been investing their money in the company business. The company gave several cases which needed to be analysed to determine whether their idea of having the SPV was important. The first case was whereby the company wanted to buy a house worth $523,000 near a University and then rent it to the students. The mortgage they were to take was $390,000 and they had planned to have rent of about $1,200 per month so as to recover the money. They had also planned that they would raise about 75% of the money by increasing the returns at a rate of 5% per year and then targeted a profit of $4,500 (Jenkins, 2015). Their plans could have worked if all conditions remained constant. However, some of the policies within the university seem to be unfavourable and in July, the chancellor of the University restricted the deductibility of the finances for the university students. The new law was to start in April 2017 and take its full effect in the year 2020. The table below shows the expectations of the company in this year after the changes in taxation and in the university rules: Source: Jenkins (2015) Commercial Analysis The table shows that by 2020 when the new regulation will be implemented in full, and the profits received by the company will have reduced. The idea of having a SPV is to make sure that if such a case happens the mother company remains safe and unaffected. The table also shows that the income tax bill will be higher than their targeted profit and therefore a special purpose vehicle will be useful to save the situation. The process will however need extra expenses. Some of these expenses include the solicitor fees, which will be used to pay for the separations of the two companies, there will be more arrangement fees to be incurred, and a guarantee from directors. Getting new customers for the new company may be a challenge too but the returns from the vehicle are worth the trial (Jenkins, 2015). In the case study above, evidence has shown that the company will need the special purpose vehicle in order to meet the goals they have for their financial years. Reasons and Advantages of Using a Special Purpose Vehicle Considering the case study above, it is easy to understand some of the reasons why a special purpose vehicle should be established. There are several reasons why the SPV should be used and the first one is that it helps to deal with the synthetics of lease, which is realised as an expense in the income statement instead of a liability in the balance sheet. The purpose gives the need to have the two types of SPV’s, which are the off-balance and on-balance. The other reason is to have a secure project which cannot be affected by the financial challenges of the mother company. For example, in the case of Jenkins, the company may have financial and operational challenges which may affect the projects they have and therefore the SPV will be helpful. The other reason is that it allows the project to be funded, owned, and managed differently from the rest of the company (Blossom, 2015). The above reasons are considered when the company decides to have a major project. Advantages and Challenges of SPV Research shows that there are many advantages and disadvantages of having the SPV in a company. The first advantage is that it reduces the chances of going bankrupt. Under a SPV, assets can be legally transferred and remain secure. Therefore, the main advantage of having the special purpose vehicle is to make sure that the funds and assets are safe from any malfunctioning of the company. The other advantage is that it helps the company to go beyond certain investment regulations and therefore opens better opportunities for the company. The company can open up new projects instead of just expanding the existing business (Blossom, 2015). It is also a good way of beating competition in that when a company runs a project that it would not want to be known to the competitors, they can conceal it and keep the competitors unaware of it. The main disadvantages of the special vehicle entity are that it is expensive to start, in that there are certain extra costs that the company has to incur at the beginning of the entity. The other one is that the company loses some tax benefits which it could have enjoyed if the splitting is not done. The other one is that it has to comply with the many restrictions of the Financial Accounting Standards Board (FASB) and may have challenges getting funds. The splitting is also challenged by the legal requirements of limited company (Blossom, 2015). The outcome is that for the SPV to be helpful, it should be set for the large projects. The Project Financing Process Earned Value Methodology Earned value methodology is a technique used in companies to manage the operations of a project. The main purpose is to compare the part of the project done with what should be done, estimating the costs and the finishing time, and analysing the variances which occur in it. The work which is already done is referred to as earned and therefore it is easy to determine if the project is within the set parameters. In the case of the SPV, the methodology can be used to come up with a work breakdown structure which makes it easy to allocate the available resources. The methodology calculates the work earned, the planned value and the actual cost of the project. It also helps to understand the schedule and costs variances which affect the project (Cullen, 2016). In order to have the SPV in time, the tool can be helpful as it looks at all possible factors and makes it easy for the management to run a project. Managing the budget for special purpose vehicle The project will need a close analysis of the costs, the possible extra costs, and other factors which can affect the budget set for the project. The first method to use is to have frequent and consistent forecast of the budget. Forecasts are useful in that they help to realise an overrun. If detected early, the overrun can be controlled and managed. The other technique is monitoring the usage of resources whereby the project managers should review the usage of the workers and other raw materials in order to determine if there is any wastage. The other technique is to have efficient communication so as to ensure that the team is well informed and are within the expectations set. The fourth way is to manage the scope of the project to make sure it does not get out of hand (Westland, 2011). For the SPV, the project should be run with care so as to make sure all parameters are in place. If not careful, more money will be spent in its establishment. When using the SPV, the credit rating of the company also increases because financial institutions view the company as more stable and which cannot easily go bankrupt in case their project fails. The risks of the business are also shared when the company has a separate management of their projects. Advantages and pitfalls of project financing In the current world, globalization has become a common trend that there are many people who operate businesses across many countries. Project financing has also become globalized and people are able to fund projects in other countries. The trend has however led to one major pitfall; language barrier. For example, a project in the United States of America may be funded by a bank in China. Understanding the language used may need an interpreter and the process may lose some of the vital information required in the project. The other outfall is the differences in the legal systems followed in different countries. In some projects, lawyers have to be hired to analyse the taxation systems, the legal liabilities, and other factors that affect a given project. The other pitfall is the ethical issues, whereby the project is expected to meet the ethical standards of the areas it is being implemented. For instance, waste disposal from a project has to be as per the legal stipulations of the country (Moffett, Stonehill, &Eiteman, 2014). If the project does not meet such targets, there is a high chance of failing. Project financing also faces gender issues whereby the funding is expected to meet the demands of both genders, but then only one gender benefits. The other gender may raise issues and protests which may delay or stop the projects. The other pitfall is cultural challenges whereby the funding fails to meet the cultural expectations of the society and therefore does not get the necessary support from the local people. The other drawback is time zone challenges whereby project financiers have challenges communicating with the people in the foreign countries. They have to stay up late so as to speak to the people in other time zones (Moffett, Stonehill, and Eiteman, 2014). In order to remain successful, a project management team should use all available measures to make sure that the project has minimal delays. Measures should be put to ensure that all these challenges have been minimized or eliminated completely. The advantages of project financing using SPV include tax benefits whereby the vehicles are exempted from some of the direct taxes. For example, in the Cayman Islands, special purpose vehicles were exempted from some taxes for a period of 20 years. The special purpose vehicle is also free from jurisdiction and the company can incorporate it in their best suiting jurisdiction. The red tape effect is also low as there is little level of management to follow, which makes the operations of the vehicle simpler. The isolation from financial risks and the legal protection are also benefits associated with the use of the SPV (PWC, 2011). Comparing the operations of the special purpose vehicle and the mother company, there are many benefits which the company can enjoy from the use of SPV. Sustainability in the Project Sustainability involves setting measures which ensure that the special purpose vehicle has high endurance and productivity for a long time amidst the challenges which face projects. If the project also maintains a good environment and does not affect the other operations, then it can be said to be sustainable. It is also the socio-ecological process in the pursuit of a common goal. In SPV, the project is sustainable if it has equilibrium between its benefits and social impacts associated with it. It is also expected to have processes and operations which are friendly to the environment (Black and Cherrie, 2010). The projects’ sustainability is based on three pillars which include; the financial sustainability, the resources used, and the ability to serve future generations (Reinecke, Manning, &Von Hagen, 2012). The level of sustainability also depends on the type of SPV used. The two types are the off-balance and on-balance. The off-balance is the one that puts the owner’s equity, assets, and liabilities on the balance sheet. The on-balance, on the other hand, puts these items as direct debt or equity. In SPV, the most common method is the off-balance, which has a thin capitalization, has no independent employees and managers, and has zero possibility of going bankrupt. The reason why this is preferred is that it has low risks, it has a higher fiancé flexibility, there is a reliable asset-liability management, and can be altered to suit the needs of the business. Special purpose vehicles are known to have a tax efficient benefit. The dividends paid to individuals from the vehicle also pay documentary tax and capital gains taxes, which go up to 25% (Blossom, 2015). For the case study above, the family company will have to pay such taxes in order to comply with the taxation laws. For more sustainability of the project, the managers of the special purpose vehicle are expected to have better planning which will ensure the project meets all its goals. Research shows that human beings use the economy, community, occupational groups, environment, government, and physiology so as to achieve all their dreams in life (Thomas, 2016). In this understanding, the family business above will use all these aspects in life to have their company working to their best interest. Sustainability will help the special purpose vehicle to grow and meet the targets set by the mother company. The project is said to have a high sustainability level if it can survive the turbulent waves of the economy. For example, in the case study given above, the owners of the family company have invested in many properties which are at a risk of making losses due to the new regulations by the university. There are chances that more of such regulations may be made, which threaten the good and smooth operations of the business. In order to avoid future losses and the collapse of business, the special purpose vehicle will be used to buy properties, while the assets and finances of the mother company remain safe. Conclusion In the current world, there are many factors which affect the operations of a business. Some of these factors are based on the location, the country, and the industry in which the company operates. An informed company management is helpful since they can be able to tell the possible impacts of the policies put in place in the industry. For example, when there are policies abolishing or introducing the use of certain products in a country, then there is a need to consider the chances the business has to operate in that future. A special purpose vehicle offers a good chance for the business to survive the turbulent environment. It separates the assets and funding of major business projects, and eliminates the chances of getting affected by the failure of the mother company and vice versa. Just like in the case study explained, the business may decide to have a special purpose vehicle to avoid such instances. References Ashman, I. (2000). Using Cayman Islands special purpose vehicles. International Financial Law Review(April): 32–34. Black, I.R. & Cherrier, H. (2010). "Anti-consumption as part of living a sustainable lifestyle: Daily practices, contextual motivations and subjective values" (PDF). Journal of Consumer Behaviour,9 (6): 437. Blossom (2015). Understanding the Complexities ofthe Special Purpose Vehicle. Blossom Wealth Management. Retrieved January 27, 2017from http://www.blossomwm.com/understanding-the-complexities-of-the-special-purpose-vehicle/ Cullen, S. (2016). Earned Value Analysis. Whole building design guide. Retrieved January 27, 2017 from https://www.wbdg.org/resources/earned-value-analysis Dyke, H. & Jennings, S. (2012). Criteria for Special Purpose Vehicles in Structured Finance Transaction. Fitch Ratings. Retrieved January 27, 2017 from https://www.fitchratings.co.jp/ja/images/RC_20120530_Criteria%20for%20Special%20Purpose%20Vehicles%20in%20SF%20Transactions_EN.pdf Jenkins, J. (2016). Case study: Purchasing a buy to let with a special purpose vehicle. Mortgage solutions. Retrieved January 27, 2017from http://www.mortgagesolutions.co.uk/better- business/2016/01/25/case-study/ Klee, K. & Brendt B. (2002). Asset-backed securitization, special purpose vehicles and other securitization issues. Uniform Commercial Code Law Journal,35:23–67. Moffett, M. H., Stonehill, A. I., & Eiteman, D. K. (2014). Fundamentals of multinational finance. New York: Pearson. PWC (2011). Creating an understanding of Special Purpose Vehicles. PWC financial regulation.RetrievedJanuary 27, 2017 from http://www.pwc.com/gx/en/banking-capital-markets/publications/assets/pdf/next-chapter-creating-understanding-of-spvs.pdf Reinecke, J., Manning, S.,& Von Hagen, O. (2012). "The Emergence of a Standards Market: Multiplicity of Sustainability Standards in the Global Coffee Industry"Organization Studies, Forthcoming. Thomas, S.A. (2016). The Nature of Sustainability. Grand Rapids, Michigan: Chapbook Press. Wan, A. & Sidoti, J. (2016). Why “Special Purpose Entities” Are So Special. Crowdfund Insider.Retrieved January 27, 2017 from http://www.crowdfundinsider.com/2016/09/90049- special-purpose-entities-special/ Westland, J. (2011). Project Management: 4 Ways to Manage Your Budget. CIO. Retrieved January 27, 2017 from http://www.cio.com/article/2406862/project- management/project- management--4-ways-to-manage-your-budget.html Read More