Special Purpose Vehicles Are Even Riskier in a Downturn

By: Gridline Team | Published: 01/18/2023
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2 minutes

At its peak, Enron's shares were worth $90.75, falling to just 26 cents when it filed for bankruptcy. The scandal left behind a wide-ranging investigation and far-reaching regulations to prevent such fraud from occurring again. But one of the most overlooked aspects of Enron's demise was how its use of special purpose vehicles (SPVs) created a web of complexity that made it difficult to monitor the company's risk exposure.

Enron creatively used SPVs to hide mountains of debt and toxic assets from investors. This technique allowed the company to increase its indebtedness without appearing highly leveraged, deluding shareholders until it was too late and the stock price plummeted.

SPVs are perfectly legal entities that can be used for any purpose, including securitization and debt financing. In venture investing, they're essentially pop-up funds that pool money from accredited investors to buy a stake in a single privately held company.

However, as we've previously explored, the risks of these vehicles come from their lack of oversight and a lack of regulation that results in the smallest investors being paired with the riskiest deals. Now, these risks have been amplified in the current bear market.

Assure Collapse Leaves Thousands Of SPVs On The Brink

An SPV administration services firm, Assure, launched over 2,000 SPVs in 2021 alone. In 2022, however, the downturn meant a slowdown of new clients, and Assure could no longer keep up with the costs associated with maintaining its platform. As a result, Assure's users now find themselves without services and with thousands of SPVs in limbo.

Users must find a new home for their funds, with thousands of dollars in new fees and a complicated process to transfer investments. Not only that, but not everyone has gotten their money out of the platform. The uncertainty of the situation has left some investors feeling vulnerable and uncertain about their investments.

Assure wrote on their site that they handled “deal setup, investor onboarding, KYC/AML, documents, banking, 1065s, K1s, and more. These services have been halted, leaving investors to manage these processes themselves.

All SPV Investors Are At Risk

Assure's customers don't just face the risk in SPVs. SPVs often represent a complete lack of portfolio diversification, meaning that investors risk losing all of their money when one company fails.

Moreover, in a bear market where private valuations have already been falling, and venture capital firms are pulling back, the risk of these investments has increased. Investors must now question whether their investments are adequately protected against losses from a prolonged bear market. With less oversight and governance than venture investing, the risk of an SPV failing is higher than ever.

Instead of relying on these pop-up funds to get exposure to private companies, investors would be better served by seeking active management that can provide proper diversification and a higher level of protection against market downturns. Gridline's platform enables access to a curated selection of professionally managed alternative investment funds, allowing investors to build diversified portfolios of private market assets with lower fees and greater liquidity.

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