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Project Financing

Introduction

Project financing refers to the long-term financing of infrastructure and industrial projects gleaned from the project's cash flow instead of balance sheets of sponsors of the project for repayment, with the assets of project, rights and interests as secondary collateral. Project financing helps companies arrange for a loan centered on the cash flow generated on the completion of the project while utilizing the project’s assets, rights, and interests as collateral.

In order to have a continuous growth and expansion of the industries at a rapid rate Project Finance is one of the key focus areas in today’s world. It is a long-term financing of infrastructure and industrial project depending upon non-recourse or limited alternative of financial structure so that the project debt and equity used to finance the project are paid back from the cash flow engendered by the project. Project Financing is a secured form of lending, accepting the project’s rights, assets, and interests as collateral. It is useful in more than one way as it can help the Company to expand the manufacturing capacity, rent a workstation, upgrade its technology, handle unexpected expenses, experimentation of a new product or service, create a cash pool, etc.

Features of project financing

A structured financial scheme is very important to be formed because when a decision on project financing is to be made, a company requires an exceptional amount of knowledge and funds for this kind of scheme. The features of such Project Financing are as follows:

Capital Intensive Financing Scheme: Project Financing is most fitting with projects that are in requirement of large amounts of funding including debt or equity financing. These schemes of project financing are more often implemented in developing countries instead of already developed countries because these projects financing helps in booming and growing the economy of the developing country. Although, these schemes usually come at a higher interest rate than normal corporate loans which also leads to an increase in the total cost of the project and reduces the liquidity as well. These projects that adopt these schemes of project financing usually entertain a higher emerging market risk and political risk that is why these projects are charged an extremely high premium.
Risk Allocation: When forming a financial plan there could be various risks that can be faced by the lender, so the lenders initially find the risk they may germinate with each project before funding it. But the lenders also receive higher premiums with Project Financing, so the high risk has its higher premiums.
Multiple Participants Applicable: A Project Financing project is usually an extremely large-scale project therefore for better functioning and effective completion of the project numerous parties are allocated in the project to follow up on different aspects involved in the project. This method helps in the smooth operation of the entire process of the completion of such a project. Asset Ownership is decided after Project completion: The Special Purpose Vehicle is responsible to overview the proceeding of the entire operations of the project while also tracking all the assets included in the project. After the completion of the project, the ownership of it depends on the terms that were previously decided during the terms of the loan.
Zero or Limited Recourse Financing Solution: In a Project Financing project the ownership of the entire project is not given to the borrower until the project is completed, this way the lender of the funds do not have to be anxious about evaluating the asset and credibility of the borrower or spend resources in finding that out. The lenders therefore only must focus on the feasibility of the project. This is also an advantage to the lender in a scenario where the project after completion is not able to generate enough cash to repay the loan.
Loan Repayment with Project Cash Flow: In Project Financing the terms of the loan describes that the surplus cash that is received from the lender to the project must be first used to pay off the outstanding debt that the borrower has. Once the debt of the project is paid off the risk exposure of the project also reduces for the lender or financial services company.
Better Tax Treatment: By implementing Project Financing, both the sponsor of the project and the project itself can find much better tax treatments for themselves. Therefore, a lot of sponsors choose this type of financing scheme to avail of the tax benefits for long term projects.
Sponsor Credit Has No Impact on Project: These long-term financing projects make sure that the credit standing of the sponsor does not have any negative impact on the project while the financing plan maximizes the leverage of the project. Thus, the credit risk of the project is much better than the credit standings of the sponsor.

Sources for Obtaining Project Finance

Venture Capitalist
Business Loan
Business Angels
Share Capital
Overdrafts
Debentures

Various Stages of Project Financing

Pre-Financing Stage

Identification of the Project Plan: - This stage of Project Financing starts with analyzing the strategies of the project and finding out whether the project is good enough for such a high investment or not. The lender must perform this step to realize if the project plan is based on the goals of the financial service company or not.
Recognizing and Minimizing the Risk: - Before the Project financing venture begins the company must calculate the risks associated with the project. Before the lender decides to invest in the project, he has a complete right to estimate the availing risks associate with the project.
Checking Project Feasibility: - Before the financial service company decides to invest in a project it must thoroughly analyze if the following project is financially and technically feasible or not.

Financing Stage

It is the most crucial part of project financing which is further classified into following points:

Arrangement of Finances: - To generate financial investment for the project the sponsor needs to generate equity or take a loan from any financial service company, which has similar goals that of the project.
Loan or Equity Negotiation: - In this step both the borrower and lender negotiate and come on the same page and decide the total amount of the loan.
Documentation and Verification: In this step both the lender and the borrower finalize the terms of the loan by mutually deciding them and documentation is prepared with keeping these terms in mind.
Payment: When the documentation of the loan is completed, the lender gives the borrower the total amount decided and the project can start its process.

Post-Financing Stage

Timely Project Monitoring: Once the project has begun its functioning the project manager needs to monitor the functioning and operations of the project carefully and regularly
Project Closure: The steps mean the completion of the project.
Loan Repayment: After the project is completed, the cash flows of the project commencement are monitored, and his cash flow is used to pay back the loan taken to finance the project.

Types of Sponsors in Project Financing

It is fruitful for the project to know all the types of sponsors that are associated with projects, this also helps you determine the objectives and the risk involved in the project. The types of sponsors available are broadly categorized into four types for Project Financing, they are as follows:

Industrial Sponsor: These types of sponsors mostly are for an upstream or downstream kind of business.
Public Sponsor: These sponsors’ main agenda is to contribute to public service and hence they are mostly associated with the government or the municipal corporation.
Contractual Sponsor: These sponsors mainly go for important players in the development and running of big plants and factories.
Financial Sponsor: These sponsors mostly take part in deals that have a sizable amount of return.

Conclusion

Project Financing is a limited and long-term financing scheme; it is used to sponsor big and high investment projects mainly. The cash flow that is generated from the completion of such projects is used to repay the loan amount that these projects take from financial service companies. In these kinds of projects, many participants are associated with handling the project and its operations and the ownership of these projects depends on the terms of the Project Financing agreement after the project is completed. This scheme also has a higher risk for the lender but in return pays them a higher premium on their investments as well.

As the Government of India continues to invest a high amount of money in the infrastructure of the country, it is predicted that the country will be under massive developments in the future for power, transportation, bridges, dams, etc. Most of these projects will be using the Public-Private Partnership (PPP) method indicating a rise in Project Financing during the upcoming years. This entire cycle will further help improve the economic condition of India.

For any kind of help regarding Project Financing, feel free to contact us.