Variable Interest Entities (VIE)
Candlefocus EditorThese entities often arise when an investor, such as a venture capitalist or a large company, wants to gain an interest in a risky or illiquid asset, like a startup or a business venture. Such an investor might choose to invest in a VIE as an alternative to purchasing a controlling interest in the underlying asset, because it can limit the amount of risk that an investor faces. The investor usually acts as the primary beneficiary of the VIE, meaning they will be entitled to the majority of the financial rewards or losses ultimately borne out of the VIE.
In the United States, public companies are required by the Federal securities laws to disclose any relationships to VIEs on their 10-K forms. During the financial crisis of 2007-2008, many of the country’s largest banks used VIEs as a way to lessen their financial exposure to the riskiest of their mortgage-related assets.
The legal structure of a VIE can be complex, and it should be accompanied by an audit from a qualified accountant to ensure the entity’s compliance with all applicable laws and regulations. Furthermore, investors within a VIE must take special care to review all of the VIE’s documents and agreements, as a VIE’s structure can sometimes give rise to conflicts of interest.
Although investing in a VIE can be beneficial in certain cases, it comes with its own inherent risks. As the principal beneficiary of the VIE, the investor will bear the majority of the risk associated with the VIE, such as a potential inability to repay debt, or the failure of the underlying asset to generate returns.
Overall, a variable interest entity is a type of business structure that can benefit investors in certain situations by allowing them to limit their risk. However, it is important to understand the legal complexities, risks, and obligations associated with participating in a VIE in order to understand its true benefits.