Project Finance
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LET US BREAK OUT PROJECT FINANCE
Financing related to long-term projects
The term loan is a long term secured debt extended by banks or financial institutions to the corporate sector for carrying out their long-term projects maturing between 5 to 10 Years which is normally repaid in monthly or quarterly equal installment. They are an external source of finance paid in installments governed by loan agreement and covenants.
Non-Recourse/Limited Recourse Financial structure
Project finance is the structured financing of a specific economic entity – a special purpose vehicle (spv) – created by the sponsors using equity or debt. The lender considers the cash flow generated from this entity as the major source of loan reimbursement.
Hence, if the borrower defaults, the issuer can seize the assets of the said spv but cannot seek out the borrower for any further compensation, even if the spv does not cover the full value of the amount defaulted.
Payment from cash flow generated by the project
Cash flows generated by the spv must be sufficient to cover payments for operating costs and to service the debt in terms of capital repayment and interest. Because the priority use of cash flow is to fund operating costs and to service the debt, only residual funds after the latter are covered can be used to pay dividends to sponsors undertaking project finance.
Why Do Sponsors Use Project Finance?
By participating in a project finance venture, each project sponsor pursues a clear objective, which differs depending on the type of sponsor. In brief, four types of sponsors are very often involved in such transactions:
1. Industrial sponsors – they see the initiative as upstream and downstream integrated or in some way as linked to the core business.
2. Public sponsors – central or local government, municipalities and municipalized companies whose aims center on social welfare.
3. Contractor/sponsors – who develop, build, or run plants and are interested in participating in the initiative by providing equity and or subordinated debt.
4. Financial sponsors/investors – plays part of a project finance initiative with a motive to invest capital in high profit deals. They have high propensity of risk and seek substantial return on investments.
Corporate Finance / Project Finance Difference
Now that we have a basic understanding of what project finance means, let us understand how project finance differs from corporate finance. The table below outlines important differences between the two types of financing that need to be taken into account.
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