Project Finance Vs Corporate Finance

While EXIM Bank’s analytical approach for project finance is different from the traditional export finance approach, many of EXIM Bank’s requirements remain the same. Typically, PF is used for capital intensive infrastructure investments that employ established technology and generate stable returns, preferably returns that are denominated or can be easily converted into hard currencies. PF is not good at funding high-risk investments with uncertain returns, so is rarely used to fund research and development spending, new product introductions, advertising campaigns, or other potentially high-return intangible investments. PF is used only for tangible, large projects with known construction risks and well-established operating technology.

• Draft turnkey construction contract and description of sources of possible cost increases and delays during construction, including detailed description of liquidated damage provisions and performance bond requirements.
• To understand the specificity of the project finance, let’s first take a look at a more conventional financing method which is corporate finance.
• Some sources (e.g., bonds) tend to impose fewer constraints on the project but those constraints may prove much harder to modify or waive.
• Department of Commerce have a Commercial Liaison Office at each of the MDBs.
• Mining projects, comprising the second largest share of worldwide project financing, are also a significant user of project finance, for similar reasons.
• Although security is taken over all project assets, the real source of repayment is project cash flow, not potential sales of the project assets upon foreclosure , so lenders have a strong interest in assuring that cash flow will continue.
• Vi Operation and maintenance agreementsThe quality of the operator and its effectiveness in operating the project are key concerns of lenders.

If the project goes wrong for any reason, Little Energy will go bankrupt, but, as the project sponsor, your company, Big Energy, won’t be responsible for repaying any of Little Energy’s debts. Although a little complicated, this kind of arrangement is used all the time in energy, infrastructure, and construction projects. EXIM Bank implements these flexibilities on a case-by-case basis for qualifying project finance transactions. Generally, extended grace periods or repayment terms must be justified by project cash flows or project considerations specific to certain industry sectors. For example, extended grace periods and back-ended repayment profiles may be justified for telecommunications projects but are likely not appropriate for power plants.

Basic Project Finance Concepts

By their very nature, these types of projects rely on a large number of integrated contractual arrangements for successful completion and operation. The contractual relationships must be balanced with risks distributed to those parties best able to undertake them, and should reflect a fair allocation of risk and reward. All project contracts must fit together seamlessly to allocate risks in a manner which ensures the financial viability and success of the project. Project finance is essentially a way to get a project done while protecting the other assets a company might have. As the project sponsor, your company, Big Energy Corp., that wants to build the project, would essentially set up a second company that will build the project. This smaller company is known as the project company; we’ll call it Little Energy Co.

There are times when an investment bank will offer buy-side financial advisory services as an additional service to lending. Since lenders believe that their loan principal will be repaid solely from the cashflows generated by the project, as opposed to the values of the assets, their focus centers on mitigating all risks around those cashflows. Due diligence in project finance involves managing and reviewing the aspects related to a deal. Proper due diligence ensures no surprises arise in regard to a financial transaction. The process involves a comprehensive examination of the transaction and preparation of a credit appraisal note. Now that we have a basic understanding of what project finance means, let us understand how it differs from corporate finance. The table below outlines important differences between the two types of financing that need to be taken into account.

Different Electricity Markets

•Project finance transaction volume often exceeds $400 billion globally, making it an important component of global financial markets and a critical method of supporting capital investment. “Project finance is a method of funding in which the lender looks primarily to the revenues generated by a single project, both as the source of repayment and as security for the exposure. External links to other Internet sites should not be construed as an endorsement of the views or privacy policies contained therein. Working with the MCC can reduce your risk if your company wants to work on a project in one of their partner countries. The MCC procurement process also emphasizes “best value” taking into account references, technical quality and past performance – which means that the lowest cost bidder does not automatically win. MCC partners with countries that are poor but well-governed, and seeks to work with more quality companies with a track record of achieving success on a similar scale. The U.S. Trade and Development Agency funds various forms of technical assistance, feasibility studies, training, orientation visits and business workshops that support the development of a modern infrastructure and a fair and open trading environment.

• Typically, the bank would lend to the buyer 70% of the value of the property and would ask the buyer to finance the remaining 30% with his own money.
• For applications proceeding to a Phase I evaluation, a financial advisor will be selected by EXIM Bank.
• Before the financial advisor begins his review , the applicant will be required to pay an evaluation fee and execute a contract with the financial advisor.
• Both types of firms will have to work hand in hand to make and keep a project operational.
• The flexible terms are offered in High-Income OECD markets only with additional constraints.

They share the characteristics of having large capital needs, in many cases having higher than average risk, occupying a politically sensitive sector, and, in the case of oil and gas, often having a number of sponsors. Lenders hold security over all material project assets, as well as the sponsors’ equity in the project company. In summary, the input from financial, legal, and technical specialist of a project will have a direct cost impact to a project. The cost impacts will ultimately affect the ability to finance and the cost in which financing can be obtained.

Legal Aspects Of Project Finance

PF is especially good at constraining governments from expropriating project cash flows after the project is operating, when the temptation to do so is especially great. At this stage, all the investments have been made and the project cash flows are committed to paying off the heavy debt load. V Construction agreementsThe principal purpose for most project financing is the construction of the project. During construction, lenders must advance most if not all of the project finance funding prior to having a finished project that can generate revenues to repay the loans.

Diane Costagliola is an experienced researcher, librarian, instructor, and writer. She teaches research skills, information literacy, and writing to university students majoring in business and finance. She has published personal finance articles and product reviews covering mortgages, home buying, and foreclosure. Full BioAmy is an ACA and the CEO and founder of OnPoint Learning, a financial training company delivering training to financial professionals. She has nearly two decades of experience in the financial industry and as a financial instructor for industry professionals and individuals. Ring-fencing is achieved when SPV has its own board of directors, its own bank accounts, its own financial reports, and accounting. This capital raising happens at the parent company level, and once the capital is raised, it is distributed to its divisions.

Introduction To The Theory And Practice Of Project Finance

These factors often make project financing expensive, particularly when compared to general corporate financing. Although security is taken over all project assets, the real source of repayment is project cash flow, not potential sales of the project assets upon foreclosure , so lenders have a strong interest in assuring that cash flow will continue. Project financing is therefore restrictive, with noticeably more information requirements, specific covenants and lender consent rights than in a general corporate financing.

Each material contract is reviewed and signed off on by the lenders, and changes will require lender approval. Project cash flow is controlled through a requirement that proceeds received by the project be deposited into a series of accounts controlled by the lenders, from which funds are disbursed in accordance with a predetermined ‘waterfall’ scheme . Developing infrastructure is a big undertaking spanning across infrastructure asset classes as well as different roles and responsibilities for each project. A project finance deal will require the services of a whole host of advisors and specialists in unrelated disciplines whose role has one thing in common- all of their input is related to the same project that must be assembled on paper in legal agreements. There are many jobs within the infrastructure industry which will require a working knowledge of project finance and understanding the “big picture” of project finance is critical for even non-financial roles in infrastructure. Alternative 1 means that the sponsors use all the assets and cash flows from the existing firm to guarantee additional credit provided by lenders. If the project is not successful, then all the remaining assets and cash flows can serve as a source of repayment for all the creditors of the combined entity .

Why Project Finance Is Not Well Suited For Small Projects

Applicable law may restrict the extent to which shareholder liability may be limited. For example, liability for personal injury or death is typically not subject to elimination. Non-recourse debt is characterized by highcapital expenditures , long loan periods, and uncertain revenue streams. Underwriting these loans requires financial modeling skills and sound knowledge of the underlying technical domain. Project Finance Modeling Blog will be featuring short articles on the project finance theory, financial modeling of project finance transactions and review of currents trends in project finance area.

Without Big Energy’s assets as collateral for any debt that Little Energy assumes, lenders can, and generally will, demand a higher return. Through “structured finance,” EXIM can consider existing companies overseas as potential borrowers based on their creditworthiness as reflected on their balance sheet and other sources of collateral or security enhancements. EXIM has done structured transactions such as multiple-country fiber-optic cable, oil and gas projects, air traffic control, telecommunications and manufacturing entities. Seventh, certain project finance may, in contrast to the usual situation, offer concessionary terms. For example, export credit agency financing to encourage the purchase of capital goods from a certain country may offer very attractive rates. In addition, some government-backed funding may offer tax advantages to the funding parties and thereby lower the cost of capital for the project. Because of its reliance on project cash flow for loan repayment, a project financing arrangement intrudes deeply into the operation of the project.

To Project Finance

This SPV then would raise debt financing from the banks, and, equity financing from its sponsor. The assets that the project will build will serve as collateral for the loan the project company raises. In addition to the general requirements for a project company, in power, specifically, the market matters. Simply put, in regulated markets, the costs of a project are generally approved by the utility commission and can be recovered through charging customers. In merchant markets, there’s more risk to building generation projects, as there’s no guaranteed cost recovery. As a result, projects in merchant markets generally require a long-term power purchase agreement with a local utility to be financially viable.

• These costs mean that if your project requires less than $50 million in loans, it’s probably too small and not ideal for this form of financing.
• Full BioAmy is an ACA and the CEO and founder of OnPoint Learning, a financial training company delivering training to financial professionals.
• In addition, risk is heightened by dependence upon the single asset or set of assets, and a single source of cash flow for repayment.
• Integrating recent developments in credit markets with revised insights into making project finance deals, the second edition offers a balanced view of project financing by combining legal, contractual, scheduling, and other subjects.

Project finance for BOT projects generally includes aspecial purpose vehicle . The company’s sole activity is carrying out the project by subcontracting most aspects through construction and operations contracts. Because there is no revenue stream during the construction phase of new-build projects, debt service only occurs during the operations phase. A description of the host government’s role in the project, and progress made toward obtaining essential government commitments, including authorizations from appropriate government entities to proceed with the project. Copies of all permits, licenses, concession agreements and approvals are required in addition to a description of all permits necessary to complete the project and their status. A description of the principal risks and benefits of the project to the sponsors, lenders, and host government. A breakdown of anticipated project costs through commissioning, including interest during construction and working capital requirements, by major cost category and country of origin.

The Market For Project Finance: Applications And Sectors

EXIM offers limited recourse project financing in most countries and has no country or project dollar limits. This explains why legal aspects are of paramount importance in deal structuring. The intricacies that lawyers must solve when advising on project finance legal design are complicated by the fact that the legal framework of project finance originated in common law systems. Their task becomes a meticulous search of the available legal instruments in civil law countries that can fit for the purpose.

MCC provides time-limited grants promoting economic growth, reducing poverty, and strengthening institutions. These investments not only support stability and prosperity in partner countries but also enhance American interests. With cost-effective projects, a lean staff, and an evidence-based approach, MCC is a good investment for the American people. Iii Supply agreementsAside from public infrastructure projects, many projects involve the conversion of some type of raw material or fuel into a useable or transportable product (e.g., liquefied natural gas, refined products, metals and electricity). The agreements under which the raw material or fuel is supplied to the project are critical to its success and must assure a supply throughout the loan term.

Certainty of project completion and construction price, and coverage for cost overruns, if any, will be major focuses of the project lenders. A single engineering, procurement and construction contractor may ‘wrap’ project risk under one agreement, or some services and goods may be separately supplied. In either case, the greater the risk to the project, the more likely it is that the lenders will insist on some level of recourse to project sponsors during the construction phase. V Sources of Project FinanceProject financing for all of these projects may be obtained from a variety of sources that are discussed in detail later in this volume. These include capital markets , commercial lenders, government funding , multilateral lenders and regional development banks, and national export credit agencies and insurers, among others. Some sources (e.g., bonds) tend to impose fewer constraints on the project but those constraints may prove much harder to modify or waive. Others (e.g., commercial lenders) may be quite intrusive with regard to project operations but easier to work with as changes occur in the project.