Project Financing

project financing

… from the desk of the CEO
David Fisher

Project finance is the financing of long-term infrastructure, industrial projects and public services based upon a non-recourse or limited recourse financial structure, in which project debt and equity used to finance the project are paid back from the cash flow generated by the project. Project financing is a loan structure that relies primarily on the project’s cash flow for repayment, with the project’s assets, rights and interests held as secondary security or collateral. Project finance is especially attractive to the private sector because companies can fund major projects off the balance sheet.

A simplified project financing structure for a build, operate and transfer (BOT) project includes multiple key elements.

Key Elements of BOT Project

Generally, a special purpose entity is created for each project, thereby shielding other assets owned by a project sponsor from the detrimental effects of a project failure. As a special purpose entity, the project company has no assets other than the project. Capital contribution commitments by the owners of the project company are sometimes necessary to ensure that the project is financially sound or to assure the lenders of the sponsors’ commitment. Project finance is often more complicated than alternative financing methods. Traditionally, project financing has been most commonly used in the extractive (mining), transportation, telecommunications, power industries as well as sports and entertainment venues.

A special purpose vehicle (SPV) project company with no previous business or record is necessary for project financing. The company’s sole activity is carrying out the project by subcontracting most aspects through construction contract and operations contract. Because there is no revenue stream during the construction phase of new-build projects, debt service is possible during the operations phase only. For this reason, parties take significant risks during the construction phase. Sole revenue stream is most likely under an off-take or power purchase agreement. Because there is limited or no recourse to the project’s sponsors, company shareholders are typically liable up to the extent of their shareholdings. The project remains off-balance-sheet for the sponsors and for the government.


Project debt is typically held in a sufficiently minority subsidiary not consolidated on the balance sheet of the respective shareholders. This reduces the project’s impact on the cost of the shareholders’ existing debt and debt capacity. The shareholders are free to use their debt capacity for other investments.

To some extent, the government may use project financing to keep project debt and liabilities off-balance-sheet so they take up less fiscal space. Fiscal space is the amount of money the government may spend beyond what it is already investing in public services such as health, welfare and education. The theory is that strong economic growth will bring the government more money through extra tax revenue from more people working and paying more taxes, allowing the government to increase spending on public services.

Non-Recourse Financing

When defaulting on a loan, recourse financing gives lenders full claim to shareholders’ assets or cash flow. In contrast, project financing provides the project company as a limited liability SPV. Therefore, the lenders’ recourse is limited primarily or entirely to the project’s assets, including completion and performance guarantees and bonds, in case the project company goes into default.

A key issue in non-recourse financing is whether circumstances may arise in which the lenders have recourse to some or all of the shareholders’ assets. A deliberate breach on the part of the shareholders may give the lender recourse to assets. Applicable law may restrict the extent to which shareholder liability may be limited. For example, liability for personal injury or death is typically not subject to elimination.

Risk identification and allocation is a key component of project finance. A project may be subject to a number of technical, environmental, economic and political risks, particularly in developing countries and emerging markets. Financial institutions and project sponsors may conclude that the risks inherent in project development and operation are unacceptable (unfinanceable).

Several long-term contracts such as construction, supply, off-take and concession agreements, along with a variety of joint-ownership structures are used to align incentives and deter opportunistic behavior by any party involved in the project.

Te patterns of implementation are sometimes referred to as project delivery methods. The financing of these projects must be distributed among multiple parties, so as to distribute the risk associated with the project while simultaneously ensuring profits for each party involved.

A riskier or more expensive project may require limited recourse financing secured by a surety from sponsors. Complex structured finance may incorporate corporate finance, securitization, options (derivatives), insurance provisions or other types of collateral enhancement to mitigate unallocated risk.

Parties to Project Financing

There are several parties in a project financing depending on the type and the scale of a project.

– Sponsor (typically also an Equity Investor)
– Lenders (including senior lenders and/or mezzanine)
– Off-taker(s) An off-take agreement is an agreement between the project company and the offtaker (the party who is buying the product / service that the project produces / delivers). In a project financing the revenue is often contracted (rather than being sold on a merchant basis). The off-take agreement governs mechanism of price and volume which make up revenue. The intention of this agreement is to provide the project company with stable and sufficient revenue to pay its project debt obligation, cover the operating costs and provide certain required return to the sponsors.
– Contractor and equipment supplier
– Operator
– Financial Advisors
– Technical Advisors
– Legal Advisors
– Equity Investors
– Regulatory Agencies
– Multilateral Agencies / Export Credit Agencies
– Insurance Providers
Hedge funds

The typical project finance documentation can be reconducted to four main types:

– Shareholder/sponsor documents
– Project documents
– Finance documents
– Security documents
– Other project documents e.g. business plan
– Director/promo tore Contribution

Loan Agreement

A loan agreement is made between the project company (borrower) and the lenders. Loan agreement governs relationship between the lenders and the borrowers. It determines the basis on which the loan can be drawn and repaid, and contains the usual provisions found in a corporate loan agreement. It also contains the additional clauses to cover specific requirements of the project and project documents.

Basic terms of a loan agreement include the following provisions.

– General conditions precedent
– Conditions precedent to each drawdown
– Availability period, during which the borrower is obliged to pay a commitment fee
– Drawdown mechanics
– An interest clause, charged at a margin over base rate
– A repayment clause
– Financial covenants – calculation of key project metrics / ratios and covenants
– Dividend restrictions
– Representations and warranties
– The illegality clause

Minority owners of a project may wish to use off-balance-sheet financing, in which they disclose their participation in the project as an investment, and excludes the debt from financial statements by disclosing it as a footnote related to the investment. In the United States, this eligibility is determined by the Financial Accounting Standards Board.

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