Providing Inter-disciplinary Advice on Project Finance Transactions

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

Project finance is long-term financing of an independent capital investment, which are projects with cash flows and assets that can be distinctly identified. Real estate project finance is a classic example.

In traditional or corporate financing, the sponsoring company (the company building the project) typically procures capital by demonstrating to lenders that it has sufficient assets on its balance sheets. That is, in the case of default, the lender will be able to foreclose on the sponsor company’s assets, sell them, and use the proceeds to recover its investment. In project finance, the repayment of debt is not based on the assets reflected on the sponsoring company’s balance sheet, but on the revenues that the project will generate once it is completed.

The sponsoring company must consider several factors when determining whether to use a corporate or project finance structure. Such considerations include the amount of capital needed, the risks involved (political risks, currency risks, access to materials, environmental risks, etc.) and the identity of the participants (whether a government, multilateral institution, regional bank, bilateral institution, etc. will be involved). As the graph below demonstrates, corporate finance most often involves private investors who provide financing in return for ownership (equity) in a project company. The focus in project finance, however, is mostly on loans to the project company, with project revenues as the source of the return on the investment to lenders.

Project finance greatly minimizes risk to the sponsoring company, as compared to traditional corporate finance, because the lender relies only on the project revenue to repay the loan and cannot pursue the sponsoring company’s assets in the case of a default. However, a sponsoring company can only use project finance where it can demonstrate that revenue streams from the completed project will be sufficient to repay the loan. In fact, lenders will often require that the sponsoring company demonstrate that it has agreements in place that will generate the required revenue (called “off-take agreements”). For example, in the case of power projects, the sponsoring company often signs contracts with distributors where the distributors agree to purchase electricity generated by the project. Therefore, project finance is most suitable for a project where there is a predictable revenue stream to support debt repayment.