Everything about Project Financing

The financing of long-term infrastructure, industrial projects, and public services using a non-recourse or limited recourse financial structure are termed as Project financing. The debt and equity used to finance the project are paid back from the cash flow generated by the project. Project finance is one of the most important points in today’s world because of continuous growth and expansion in the industries at a rapid rate. Project finance is different from the traditional form of finance because the credit risk associated with the borrower is not as important as in any ordinary loan transaction; the most important thing is the identification, analysis, allocation, and management of every risk associated with the project.

Key Features of Project Financing

Since a project deals with huge amounts of funds, it is important that you learn about this structured financial scheme. Below mentioned are the key features of Project Financing:

• Capital Intensive Financing Scheme: Project Financing is ideal for ventures requiring a huge amount of equity and debt, and is usually implemented in developing countries as it leads to the economic growth of the country. Being more expensive than corporate loans, this financing scheme drives costs higher while reducing liquidity. Additionally, the projects under this plan commonly carry Emerging Market Risk and Political Risk. To ensure the project is against these risks, the project also has to pay expensive premiums.
• Risk Allocation: Under this financial plan, some of the risks associated with the project are shifted towards the lender. Therefore, sponsors prefer to avail this financing scheme since it helps them mitigate some of the risks. On the other hand, lenders can receive a better credit margin with Project Financing.
• Multiple Participants Applicable: As Project Financing often concerns a large-scale project, it is possible to allocate numerous parties in the project to take care of its various aspects. This helps in the seamless operation of the entire process.
• Asset Ownership is Decided at the Completion of Project: The Special Purpose Vehicle is responsible to overview the proceedings of the project while monitoring the assets related to the project. Once the project is completed, the project ownership goes to the concerned entity as determined by the terms of the loan.
• Zero or Limited Recourse Financing Solution: Since the borrower does not have ownership of the project until its completion, the lenders do not have to waste time or resources evaluating the assets and credibility of the borrower. Instead, the lender can focus on the feasibility of the project. The financial services company can opt for limited recourse from the sponsors if it deduces that the project might not be able to generate enough cash flow to repay the loan after completion.
• Loan Repayment With Project Cash Flow: According to the terms of the loan in Project Financing, the excess cash flow received by the project should be used to pay off the outstanding debt received by the borrower. As the debt is gradually paid off, this will reduce the risk exposure of financial services companies.
• Better Tax Treatment: If Project Financing is implemented, the project and/or the sponsors can receive the benefit of better tax treatment. Therefore, this structured financing solution is preferred by sponsors to receive funds for long-term projects.
• Sponsor Credit Has No Impact on Project: While this long-term financing plan maximizes the leverage of a project, it also ensures that the credit standings of the sponsor have no negative impact on the project. Due to this reason, the credit risk of the project is often better than the credit standings of the sponsor.

Nature of project 

1. New / Green Field Project
2. Expansion of existing facilities at the same or different location 
3. Forward / Backward Integration 
4. Diversification 
5. Drafting Debt Restructuring Schemes

Importance of project finance decisions 

1. Irreversible in nature.
2. Impact long-term profitability of the business. 
3. Impact on the competitive position of the business. 
4. Impact on risk perception about the Company

What Are the Various Stages of Project Financing?

1. Pre-Financing Stage

. Identification of the Project Plan — This process includes identifying the strategic plan of the project and analyzing whether its plausible or not. In order to ensure that the project plan is in line with the goals of the financial services company, it is crucial for the lender to perform this step.

• Recognizing and Minimising the Risk — Risk management is one of the key steps that should be focused on before the project financing venture begins. Before investing, the lender has every right to check if the project has enough available resources to avoid any future risks.
• Checking Project Feasibility — Before a lender decides to invest in a project, it is important to check if the concerned project is financially and technically feasible by analyzing all the associated factors.

2. Financing Stage

• Arrangement of Finances — In order to take care of the finances related to the project, the sponsor needs to acquire equity or loan from a financial services organization whose goals are aligned to that of the project
• Loan or Equity Negotiation — During this step, the borrower and lender negotiate the loan amount and come to a unanimous decision regarding the same.
• Documentation and Verification — In this step, the terms of the loan are mutually decided and documented keeping the policies of the project in mind.
• Payment — Once the loan documentation is done, the borrower receives the funds as agreed previously to carry out the operations of the project.

3. Post-Financing Stage

• Timely Project Monitoring — As the project commences, it is the job of the project manager to monitor the project at regular intervals.
• Project Closure — This step signifies the end of the project.
• Loan Repayment — After the project has ended, it is imperative to keep track of the cash flow from its operations as these funds will be, then, utilized to repay the loan taken to finance the project.

Role of Finance Professionals 

Before Commencement of project.

◦ Assist in project identification.

◦ Carrying out Technical, Commercial & Financial Feasibility Study.

◦ Preparation of Detailed Project Report (“DPR”)

◦ Assisting in selecting optimal capital requirement/structure.

◦ Arranging for finance & negotiations with the financers.  Equity funding  Debt Funding

◦ Negotiations with the vendors/contractors for the project. (Beneficiary: Borrower)

◦ Independent appraisal of the project.

◦ Vetting of DPR’s

◦ Carrying out TEV Studies of business ventures

◦ Certification about the net worth of the borrowers (Beneficiary: Lender)

During the implementation of the project

Periodic reports / certifications:

◦ Work Progress.

◦ Cost Incurred.

◦ Sources of Finance used in the Project.

◦ Act as Lender Independent Engineer. (Beneficiaries: Borrowers / Lenders)

At the Completion Stage

◦ End-use of funds report (Beneficiary: lenders)

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