Project finance is the long-term financing of projects based on their projected cash flows. It is a finance structure which involves equity investors who are often sponsors, as well as a syndicate of banks which provide loans to the operation. The loans are non-recourse which are secured by the project assets only and are paid from the cash flow of the project. Project finance is required for huge projects such as infrastructure and construction which involve many companies and where heavy capital expenditure is incurred.
The Parties in a Project Finance Transaction:
- Sponsor: A sponsor is an entity that manages the project. The sponsor is the owner of the separate project entity created for the project. The sponsor will receive profit made from the project as dividend if he has an equity stake or management fees.
- Borrower: There may be several borrowers in a project finance transaction as many companies would have come together for the project.
- Financial Adviser: The sponsor may appoint a bank to provide it financial advisory services. If the project is being hosted in another country, the adviser needs to be thorough with legal requirements and transaction procedures in that country.
- Lenders: Project finance requires huge amounts of funds. The lender is usually not just one bank but a syndicate of banks.
- Technical Adviser: These are people or organizations which advise the sponsor and lender on technical matters. They prepare feasibility reports and monitor technical details of project performance.
- Lawyers: Often, project finance involves international transactions. Lawyers are appointed to advise on legal aspects related to rules and regulations, permits, drafting of documents, taxation etc.
- Equity Lenders: These may be lenders or project sponsors who may not have an active role in the management of the project.
The Various Advantages of Project Finance:
- Limited Risk: In project finance, only assets associated with the project are secured. The other assets of the various companies involved in the project cannot be used for settling loans in case of default.
- Project Finance Risk: Project finance is generally provided by a group of banks. Though the risk is huge, it is spread among many lenders.
- Long-Term Finance: Project finance is required for huge capital intensive projects which take a long time to complete and where the expenses cannot be recovered within a short span of time. So, funds are required for long periods of time, maybe even 20 years and more. The normal sources of corporate finance do not provide loans for such long periods.
Project Finance is often used for Public Sector Projects in Different Forms:
- BOOT (Build, Own, Operate, Transfer): These are public sector projects which build, own and operate the project for a predetermined period of time. They profit from the revenues they earn during the period of operation. At the end of the period, ownership is transferred to the public sector organization which initiated the project.
- BOT (Build, Operate, Transfer): These projects are built and operated either by the private company or by the special entity formed especially for these projects. Though the entity can earn profits from operation, ownership remains with the public sector organization.
- BOO (Build, Own, Operate): These projects are built, owned and operated by the private company which was allotted the project. The project will remain with the private company throughout its life.