Meaning

Project Financing is the funding of long term projects, such as public infrastructure and services, oil, gas and other industrial projects.

It is a method of financing on very large capital intensive projects, for longer period, where the lenders rely on the assets created for the projects as security, and the debt and equity are paid back with additional profit from the cash flow generated from the projects.

In simple words, project financing is financing on the security of the project which is based upon non-recourse or limited recourse against the sponsors of the project.

{Non-recourse means the loan borrowers (sponsor for project) and shareholders of the borrower have no personal liability involved the event of monetary default.}

It is a type of BOT (build, operate, transfer) model, where funds are arranged through a Special Purpose Vehicle (SPV) which is created by sponsors using equity or debt. However if the borrower (sponsor for project) has a debt-default, the debt-issuer has the right to seize the assets mentioned in the said SPV documentation.

Example of project financing in India includes metro railways, mono rails, sea link, construction of new bridges, roads and highways, etc.

Who are the sponsors in Project Finance?

1) Industrial sponsor

These are those businessman whose businesses’ get positive impact in some or the other way if the project is executed successfully.

2) Public sponsor

These can be associated as government or other corporative societies that have the public interest in mind.

3) Contractual sponsor

These sponsors are mainly involved in the development, operations, and maintenance of the project.

4) Financial sponsor

These are the real investors who put heavy amount on the project expecting a high return.

What are the stages of Project Financing?

1) Pre-financing Stage

• Identification of the project plan –

This is the first step in project financing where a project is first introduced to the sponsor, Here Sponsor has to properly analyze the project inside out and make a further decision of whether the investment is reasonable or not.

• Recognizing and minimizing the risk –

The lender has a right to check if the project has enough resources to complete a project. Risk management is the key step which is performed before making a financing decision.

• Checking project feasibility –

Before a lender decides to invest on a massive project, it is important to check whether or not a project is getting permission of government and approval from public. If the project is not getting enough support from public and government, then investing in it will be a big loss for a sponsor not only in finance but in reputation as well.

2) Financing Stage

• Arrangement of finances

The sponsor arranges the funds from various sources such as acquiring equity or taking loan from a financial services organization.

• Equity or loan negotiation

The borrower (project sponsor) and lender negotiates the loan amount and come to a decision.

• Verification of Documents

Documents are signed between both the parties keeping the project policies (agreement of non-recourse or limited recourse against sponsor’s assets) in mind.

• Payment

Once the documentation process is completed, the borrower (sponsor) receives the negotiated funds in order to carry out the operation of project financing.

3) Post-Financing Stage

• Project Monitoring

After investing the funds, it is a responsibility of the project manager to monitor the project at regular intervals.

• Project Closure

This step includes the end of a project.

(Duration can be of years or decades based on the project size and available resources).

• Loan Repayment

After the project is ended successfully, it is necessary to keep the track of the cash flow from its operations, as some amount from the profit will be then used to repay the loan taken from institution/bank.

Conclusion

Project financing is a long term, non-recourse or limited recourse investing scheme that is used in the development of massive projects, which can be repaid using the cash flow obtained after the project is completed.

Multiple participants are allowed to handle the project however the ownership of project is entitled only after the successful completion of the project. This financial scheme offers better margin to investors. However the risk is shared between the sponsors and the lenders (loan taken by sponsors).

Reference

• investopedia.com
• cleartax.in
• bankbazaar.com
• corporatefinanceinstitute.com
• efinancemanagement.com
• thirdway.org
• lexology.com
• resurgentindia.com
• wallstreetmojo.com
• loanbaba.com
• sciencedirect.com
• sbi.co.in

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