Project Finance

Project finance is the strategy to raise long-term debt funding for big projects through a limited recourse or non-recourse monetary system. It aids in designing a profitable structure and delimiting the shareholders’ risks through risk diversion to other parties. Moreover, the project finance includes a brief description of its management, modelling structure, and meaning. 

Please note that industries with a predictable market and less technical risks (power generation, infrastructure, and oil production) normally utilize this financing technique. Additionally, the project stays off the balance sheet for both sponsors and the host administration. 

• The project finance meaning implies a financing approach that utilizes capital produced by the project to offer the creditor’s debt obligations and investor returns. 
• There are four types of project financing sponsors: industrial sponsors, public sponsors, contractor sponsors, and financial sponsors. 
• It has three crucial sources, i.e., debt, equity, and loan. Please note that it depends upon the structuring of the project. 
• Typically, it is employed in industries with a predictable market and few technical risks, including infrastructure, oil production, and power generation. 

Project finance involves organized funding of the particular business entity generated by the sponsors utilizing debt or equity, namely, a special purpose vehicle (SPV). Moreover, the moneylender regards the capital obtained through it as a crucial compensation source.  

In the case of debtors with debt default, the creditors may rightfully confiscate the said SPV’s assets. Nevertheless, the latter is not entitled to further additional assets even when the liquidating assets of SPV are insufficient to offset the owed amount. Moreover, both technical analysis and cost-benefit analysis are essential before beginning the asset-based financing procedure. 

The working capital produced by SPV must be certainly enough to cover business expenses and manage the debt on a priority basis, concerning capital refund and interest. Subsequently, the firm may utilize the residual income for dividends paid to financiers backing the project. 

Furthermore, it is crucial to carefully review any project framework off the balance sheet under relevant legislation and accountancy regulations. Regarding project finance modelling, different kinds of sponsors seek a certain objective as per their preferred course of action. One of its main advantages is that it offers the project’s off-balance-sheet funding.

Additionally, it transfers a few project risks to debtors, such as political risks and the exchange rate risks (as interest payable soars).

To clarify, the following are four categories of sponsors:

Industrial Sponsors

The industrial sponsors are an intrinsic part of project finance management, generally lined up with a downstream or upstream business. 

Public Sponsors

Please note that these incorporate regional or central administration, municipalized firms, and municipalities with objectives concentrated on public welfare. 

Contractor Sponsors

As the name suggests, contractor sponsors establish, manufacture, or operate business units and wish to join the initiative through offering subordinated debt and/or equity. 

Investors Or Financial Sponsors

They possess a high-risk appetite, seek a considerable return on investment (ROI), and aim for capital investment in more profitable deals. 

To clarify, here are some examples to comprehend the project finance meaning. 

Example#1

Say, Xavier is the CEO of a multinational named Salvatore Oil Corporation (holding or parent company) with 30 years of industry experience and some stock holdings and other assets. Now, he plans on undertaking a new project through project finance management.  

Considering the risks involved, he established another firm for project development (project company) called Salvatore and Sons Oil Co. So, Salvatore Oil Co. will own mostly all or complete equity in Salvatore and Sons and possibly handle the regular business operations. 

The independent creditors will also offer loans to Salvatore and Sons for further funding. As a result, Salvatore and Sons will face insolvency in case of project failure, but Salvatore Oil (project sponsor) is not liable for the former’s debt repayment. 

Example#2

Mitsubishi Corporation (MC) and Hokkaido Electric Power Company (Hokuden) entered into the project finance arrangement with Sumitomo Mitsui Trust Bank, Ltd. and North Pacific Bank. To clarify, this agreement signed in March 2022 will assist in financing the collaborating operations of MC and Hokuden. 

Donan Hydro will lease current waterways and other Hokuden-owned amenities as per the plan. The latter will apply its specialization in sustaining, functioning, and constructing hydropower services to the replacement. Also, MC will utilize its vast knowledge in the project finance modelling-driven power-generation companies covering projects in both Japan and worldwide. 

Now, let’s go through the below-mentioned three major sources:

1. Debt

It is categorized into private and public debt. Investment banks raise the former and have cheaper capital costs as debt holders are paid on a priority basis. At the same time, the administration raises public debt with more reasonable capital costs due to being a government-sponsored program. 

2. Equity

Equity financing entails government-issued debt on the recommendation of an investment consultant or bank and is relatively more costly than debt financing. It is developed to reimburse higher risks presumed by the equity investors wielding the junior attestation to the project’s income and assets. 

3. Loan

It is categorized into two types, secured and unsecured loans. In the former, the loan-securing assets have value as collateral, implicating the marketability and liquidity. While the latter depends upon the debtor’s basic creditworthiness, contrary to the perfected security system. 

This article has been a guide to Project Finance and its Meaning. Here we explain its management, its sources, modelling course examples, and sponsors. You can learn more about finance from the following articles: -

• Formula for Finance Charge
• Best Project Finance Books
• Project Finance vs. Private Equity