Project Finance

What Is Project Finance?

Project finance is the funding (financing) of long-term infrastructure, industrial projects, and public services utilizing a non-recourse or limited recourse financial structure. The debt and equity used to finance the project are paid back from the cash flow produced by the project.

Project financing is a loan structure that depends fundamentally on the project's cash flow for repayment, with the project's assets, rights, and interests held as optional collateral. Project finance is especially appealing to the private sector since companies can fund major projects off-balance sheet (OBS).

Understanding Project Finance

The project finance structure for a build, operate, and transfer (BOT) project incorporates various key components.

Project finance for BOT projects generally incorporates a special purpose vehicle (SPV). The company's sole activity is carrying out the project by subcontracting most angles through construction and operations contracts. Since there is no revenue stream during the construction phase of new-build projects, debt service just happens during the operations phase.

Thus, parties face critical challenges during the construction phase. The sole revenue stream during this phase is generally under a offtake agreement or power purchase agreement. Since there is limited or no recourse to the project's patrons, company shareholders are commonly responsible up to the degree of their shareholdings. The project stays off-balance-sheet for the supporters and for the government.

Not all infrastructure investments are funded with project finance. Many companies issue traditional debt or equity to attempt such projects.

Off-Balance Sheet Projects

Project debt is commonly held in an adequate minority subsidiary not consolidated on the balance sheet of the separate shareholders. This lessens the project's impact on the cost of the shareholders' existing debt and debt capacity. The shareholders are free to involve their debt capacity for different investments.

Somewhat, the government might utilize project financing to keep project debt and liabilities off-balance-sheet so they occupy less fiscal room. Fiscal space is the amount of money the government might spend past the thing it is as of now investing in public services like wellbeing, welfare, and education. The theory is that strong economic growth will bring the government more money through extra tax revenue from additional individuals working and paying more taxes, permitting the government to increase spending on public services.

Non-Recourse Financing

At the point when a company defaults on a loan, recourse financing gives lenders full claim to shareholders' assets or cash flow. Conversely, project financing assigns the project company as a limited-liability SPV. The lenders' recourse is accordingly limited principally or completely to the project's assets, including completion and performance guarantees and bonds, in case the project company defaults.

A key issue in non-recourse financing is whether conditions might emerge in which the lenders have recourse to some or the shareholders' all's assets. A purposeful breach with respect to the shareholders might give the lender recourse to assets.

Applicable law might confine the degree to which shareholder liability might be limited. For instance, liability for personal injury or death is normally not subject to elimination. Non-recourse debt is portrayed by high capital expenditures (CapEx), long loan periods, and unsure revenue streams. Underwriting these loans requires financial demonstrating abilities and sound information on the underlying technical domain.

To seize deficiency balances, loan-to-value (LTV) ratios are typically limited to 60% in non-recourse loans. Lenders impose higher credit standards on borrowers to limit the chance of default. Non-recourse loans, on account of their greater risk, carry higher interest rates than recourse loans.

Recourse versus Non-Recourse Loans

On the off chance that two individuals are hoping to purchase large assets, like a home, and one gets a recourse loan and the other a non-recourse loan, the moves the financial institution can initiate against every borrower are unique.

In both cases, the homes might be utilized as collateral, meaning they can be seized ought to either borrower default. To recover costs when the borrowers default, the financial institutions can endeavor to sell the homes and utilize the sale price to pay down the associated debt. On the off chance that the properties sell for not exactly the amount owed, the financial institution can seek after just the debtor with the recourse loan. The debtor with the non-recourse loan can't be sought after for any extra payment past the seizure of the asset.

Highlights

• A debtor with a non-recourse loan can't be sought after for any extra payment past the seizure of the asset.
• Project debt is regularly held in an adequate minority subsidiary not consolidated on the balance sheet of the particular shareholders (i.e., it is an off-balance sheet thing).
• This frequently uses a non-recourse or limited recourse financial structure.
• Project finance includes the public funding of infrastructure and other long-term, capital-concentrated projects.