Project Finance vs Private Equity | 6 key differences

You are just starting to learn finance, and you have heard about both – Project Finance and Private Equity. You have mixed feelings about these careers. As they are in the finance domain, you feel that you would love each of these no matter what. But is it? We will bust some myths and show you how you need to approach your career in these two completely different subjects.

Here's the flow we will follow – we will first talk about why you should study both of these subjects (both are very vast in scope and opportunities); then we will define both of them; then we will discuss important concepts in each of these subjects; then we will talk about the compensation, education and work-life balance; and finally we will do a comparative analysis between these two.

Sounds good?

Let's bust the confusion and slake your thirst for knowing these two in little more detail.

Project finance is the art of financing a project, often quite large, from different sources of funds. So if you know project finance, it would help you understand how the whole process is being taken care of. For example, suppose you join a bank after studying and see that your bank works as a financier for a project management company. You need to know in greater detail how the bank will decide to invest in the project or not invest. The bank will see the projected cash flow through financial modeling, and then if the projected cash flow seems satisfactory, it will only sanction the loan. You also need to know what collateral the project management company will keep as a mortgage as they can't mortgage their company assets.

In the case of private equity, you need to be pretty good with investment analysis. In private equity, you are part of a firm where many investors will come together to invest in a worthy business. So you can understand that many businesses need funding. But a private equity firm will only invest in a business where the ROI is highest. So it would help if you did a comparative investment analysis to figure out how many opportunities cost you are incurring as a result of deciding to invest in a particular business. Often people confuse investment banking and private equity, but both are different. In investment, the banking consultant arranges funds for businesses/clients. Investment banking is a capital-raising service. Whereas a private equity firm invests; as a part of the analyst team in private equity, your job is not to advise but to invest.

Studying these two subjects will give you typical concepts and knowledge about these two kinds of sub-domains of finance. And both are very much prevalent in our business world nowadays.

What is Project Finance?

Project finance is useful when a firm/s decides to start a large project, usually an industrial or renewable project. Any project needs funding. At the beginning of the project, there were no assets. So how would the loan be arranged? The financiers or the sponsors (often equity investors) decide to see the projected cash flow of the project and then invest based on the projected cash flow. What if the project doesn't earn as much cash flow as projected. How would they pay the amount invested in the project? To solve this issue, the project assets used in the project are used as collaterals. If, by any chance, the project doesn't earn that much cash flow and thus cannot pay off, then the project assets are taken over by the financiers or sponsors.

Now, the above is just an overview of project finance. There is much nitty-gritty of this. Many parties and documents are used as a part of the process, which you will get to know in the later sections.

What is Private Equity?

There's no doubt that private equity is completely different from project finance. In the case of private equity, there are usually four functions. The first and most important function is fundraising. Normally fundraising is being done by the senior associates. But as juniors also, there are:

• Ample opportunities to analyze past performance.
• Past investors.
• The strategy used in the past.

Often, as junior associates, you need to do credit analysis. The second function is screening. In screening, the junior associates take pivot roles. First, they look for all the opportunities and screens using financial models (DCF Valuation, Net Present Value method, etc.). Next, they see whether investing in these projects would be profitable or not. The third function is managing investments and portfolios. Fourth, associates help turn around operations and help increase operational efficiency (EBITDA, ROE, etc.). Lastly, private equity associates work on their fourth main function: to analyze the exit strategy that needs in-depth analysis.

Private equity associates need to be thorough with financial models. They also need to have in-depth investment knowledge and be aware of the market changes now and then. Go for this profession if you have a knack for analysis and a passion for investment in a broader sense.

Project Finance

This section will learn a few project finance concepts and learn about the parties involved and the required documents.

• Project development: One of the most important concepts you need to know is project development. Project finance is all about sequentially funding a project. So it's important to know the stages of project development –
• Pre-bid stage
• Contract negotiation stage
• Money-raising stage

• Parties involved: There are many parties involved in project finance. Let's look at all these parties in brief –
• Sponsors: People who sponsor the project are often equity investors.
• Lender: Financial institutions that lend money for the project.
• Financial advisors help the parties understand how much return on investment they can make. They can be on both sides – lenders or borrowers.
• Technical advisors: Often, technical consultants are hired to execute the project effectively. They act as technical advisors for the project.
• Legal advisors: As the name suggests, they help in legal matters.
• Debt Financier: People who give secured loan for the project based on project assets.
• Equity Investors: People who invest the money instead of shares
• Regulatory agencies: Generally, government authorities take care of the regulations regarding the project's intricacies.
• Multilateral agencies: The agencies are part of the World Bank group.
• Document required: There are a few documents that are of utter importance. Let’s have a look at them –
• Shareholder/sponsor documents
• Finance documents
• Project documents
• Other project documents
• Financial Models: Before investing, any investor wants to know how their money would be recouped. Similarly, when they are requested to invest in a project, the sponsors need to know how the project will do. Thus they hire people who can calculate projected cash flow to understand the project's merit and how much ROI they can expect out of it. And the projected cash flow is calculated through financial modeling. Financial modeling is just a spreadsheet composed of important calculations.

Private Equity

A few concepts will give you a hint of what you can expect under private equity as you learn more about private equity. Let's have a look –

• Private equity investors: In general, investors who invest in the business in place of the ownership of those businesses will be called private equity investors.
• Angel Investors: Investors who invest in start-ups and often very risky businesses are named angel investors. Angel Investors often take a major role in the company after they invest.
• Venture Capitalists: Venture capitalists are a group of investors who pool their money and invest in private businesses. Do check out the difference between Private Equity and Venture Capital.

As project finance professionals, your compensation is huge. A project finance professional gets around US $100,468 per annum. But you need to arrange everything from top to bottom. You will have fewer options to delegate the tasks if there's even a little discrepancy; then, you would be answerable to your seniors. To be a project finance professional, you need to have a few years of experience before taking charge.

If you work as an associate in private equity firms, you get paid well. And it is as lucrative as investment banking professionals. Depending on how much value you bring to the marketplace, your compensation ranges from US $100K – to $220K per annum. So there is no wonder why many finance professionals aim to be hired by private equity firms.

The prerequisite to being a project finance professional is to have a knack for analysis and solving problems that may arise out of nowhere. Along with that, you need to do your MBA in Finance from a reputed institute. After going through India's top 25 project finance profiles, we have concluded that an MBA is a must to reach higher in an organization that helps build projects. Other than that, if you have any background in Chartered Accountancy, Cost Accountancy, or a degree in Law and have an MBA from a sought-after B-School, you will create magic in project finance.

Private equity professionals need to have more knowledge of investment. Thus, if they do an MBA in Finance, that's good. But they need some value addition as well. The best course to pursue if they want to be the topmost professionals in private equity would be CFA. This course is so well-designed that it is regarded as the best course for anyone who wants to thrive in investing. CFA is not an easy exam to pass. But if you are committed to making your mark as a private equity professional, you will clear it in due time. Remember, commitment is the key.

The work pressure is much more than a normal 9 to 5 professional in project finance professionals. As project finance professionals need to handle multiple things simultaneously, they need to invest a minimum of 12 hours a day or even more. Normally, they rarely work on weekends, but they may need to work if any crisis arises and solve the issue immediately. Thus, project finance professionals maintain a good work-life balance.

Private equity associates also invest 12 hours a day working. But, I usually don't work on the weekend and rarely need to be present all night for the analyses. So their work-life balance is also taken care of. In addition, they get enough time to mingle with their families and practice a hobby.

Let's look at some of the differences between project finance and private equity –

• The main difference between private equity and project finance is a matter of context. Project finance helps projects thrive, whereas private equity helps businesses (usually the best, not always) reach the top.
• Private equity investors often finance a project. So there is a direct link between project finance and private equity, where both serve the same purpose.
• Private equity is not limited to only project finance. The investors also invest in thriving or start-up businesses depending on the idea's marketability and the value the businesses are bringing to the table.

• Private Equity in Russia
• Private Equity in India
• Corporate Finance vs. Project Finance Differences
• Equity Research vs. Private Equity

Both of these subjects are vast, and they have ample career opportunities. So ask yourself – "What's most interesting to me?" and "Why?" If you can answer these two questions clearly, you will be able to choose a career you will be proud of shortly.