Question

JV, a corporation, was formed in 20X9 to design and manufacture electric cars. JV is 60 percent owned by AutoCo (a car manufacturer) and 40 percent owned by Electric Co (a developer of electric car technology). The decision-making authority of JV is equally shared between AutoCo and ElectricCo: the JV board of directors is composed of two members appointed by AutoCo and two members appointed by Electric Co. JV's board of directors (1) sets the annual budgets; (2) is responsible for the hiring, firing, and compensation of management; and (3) approves all material contracts. As part of the agreement, all cars produced by JV will bear AutoCo's logo and will be sold at AutoCo branded auto dealers. AutoCo is an established car manufacturer that has been producing cars in the United States for the past century. To meet governmental mandates of lowering emissions and increasing the fuel economy of its fleet, AutoCo has been evaluating various ways to enter the electric vehicle market. AutoCo does not currently have viable technology for the production of electric cars. ElectricCo was established by professors that developed cutting-edge battery technology for electric cars. Although ElectricCo has not produced electric cars in a mass market, the battery technology is tested and highly valued. AutoCo and ElectricCo jointly formed JV to produce electric cars for the mass market. JV benefits from ElectricCo's proprietary technology and AutoCo's manufacturing expertise and access to credit markets and distribution channels. JV is financed with 30 percent equity and 70 percent debt. When JV was formed, ElectricCo did not have access to sufficient cash at inception to fund its equity interest. To purchase its equity interest, ElectricCo received a loan from AutoCo. The debt financing was obtained in the form of a credit facility from a third-party bank. For the bank to provide debt to JV, it required that AutoCo guarantee the loan. Is JV a VIE? Which of the following indicators of a VIE are present for JV? Answer "Yes" or "No" A related party (i.e., the potential parent company) significantly contributed to JV's design A substantial part of JV's activities are conducted on behalf of the potential parent company More than half of the financing is provided by the parent company The primary goal of JV is to provide asset-backed financing or lease arrangements related to the primary activity of the potential parent company

Answer 1

Yes. JV is a Variable Interest entity (VIE) because of the following reasons:

• The investors do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support.
• As a group, the holders of the equity at risk (generally members or partners) lack the power, through voting or other rights, to direct activities that most significantly impact a joint venture’s economic performance.
• As a group, the holders of the equity at risk (generally members or partners) lack the obligation to absorb a joint venture’s expected losses, or have the right to receive a joint venture’s expected residual returns.
• Moreover, one party i.e. AutoCo. in the above case provides some form of guarantee on behalf the joint venture. Thus it is a VIE.

A related Party(i.e. the potential parent company) significantly contributed to JV's design- Yes as to purchase Equity interest ElectricCo. received a loan from AutoCo.

A substantial part of JV's activities are conducted on behalf of the potential parent company- No as the decision making authority of JV is shared equally between AutoCo. and Electric Co.

More than half financing is provided by the parent company- Yes because when JV was formed, Electric Co. did not have sufficient cash.

The primary goal of JV is to provide asset-backed financing or lease arrangements related to the primary activity of the potential parent compnay- No, beacuse JV is formed to produce electric cares for the mass market.