A special purpose entity technically is a business that is created to handle a specific project or oversee certain assets. This type of company generally serves as a subsidiary of a larger business. Its structure is designed to protect investors or creditors in the event of bankruptcy within the parent company. Considering this, a special purpose entity is often called a bankruptcy remote entity.
Special purpose entities are created for a variety of reasons. The exact process involved can vary, but there are a few key factors that go into the creation of a solid secondary enterprise.
Reasons to Create a Special Purpose Entity
A special purpose entity may be created for a wide variety of business reasons. Some of the more common include:
- Securing loans – It is not uncommon to see a company create a special purpose entity to protect investors in a certain project or asset. Mortgage-backed securities issued by banks, for example, might come from a special purpose entity to ensure that investors are given the priority to receive any payments from the loans.
- Spreading risk – A company may create a special purpose entity to handle a high-risk project or asset to protect itself and investors from financial loss. This also enables other investors to come on board and take a share in the risk and the potential rewards.
- Transfer of assets – In certain cases, it is beneficial for a company to have a special purpose entity own a hard-to-permit operation. This enables the company to sell the special purpose entity as a standalone business if it so chooses.
Starting a Special Purpose Entity
A special purpose entity is formed like most other corporations. It must have an operational team and will also often have its own investors. Since this type of company is created to standalone from the main sponsoring firm, it should offer fewer risks for investors if a high-risk asset or project does not pan out. The idea behind this type of company is to have as few financial obligations as possible so investors will feel comfortable. The creation of two businesses instead of just one essentially protects both companies from the other’s financial ups and downs.
Traits of a Solid Special Purpose Entity
When a special purpose entity is handled appropriately, it will stand on its own financially. Ideally, this type of company will bolster the main company without detracting from it if financial issues do arise.
Hiring an Attorney
Creating a special purpose entity is an effort that is designed to help protect investors from worries about bankruptcy. Since this type of company has a limited focus and limited investors, those involved will take first priority if financial problems do arise. Establishing this type of standalone business does require following proper legal channels. It is best to consult with a reputable attorney before trying to create a special purpose entity.
