What is Project Finance? Member, Advantages, and Limitation

Introduction

We all know finance plays an integral role in any business and non-business project. Some people take short-term capital and some belief in making long-term financial plans.  To analyze the thorough life-cycle of heavy industrial work, project finance is introduced by financial experts. 

What is Project Finance?

The funding or financing that is being utilized for industrial projects, public utilities, and long-term infrastructure is known as project finance. The projects are established on the estimated cash flows as a substitute for the balance sheet. Equity investors are part of project financing are called sponsors that give loans to the industrial parties.     

It is operated as distinct entities from the parent throughout the lifetime of a project. This business venture is an off-balance sheet module hence all the capital must be payback solely out of cash flows.

Each year, over $230 billion in project finance proceeded. Groups of investors work conveniently and the risk of the financing is divided among all members.

The project development procedure goes through the pre-bid stage, agreement negation phase, and lastly finances raising stage.  All stages require continuous expert consultancy and project monitoring.

Member Involved in Project Finance Operations

  • Sponsors: The equity capital shareholder of the company. Two or more sponsors are involved in the financing of the parent company that seeks project finance.
  • Financial Institute/Banks: They are the lenders that issue the senior debt. The loans given by banks are highly secured against special purpose vehicle (SPV) assets and cash flows. 
  • Special Purpose Vehicle (SPV): Sponsors of the project float the separate legal institution is known as SPV.  The special purpose vehicle functions as the corporate veil between the parent company and the financial institute. 
  • Host Government: It is the home country when a special purpose vehicle is established. The whole work must be done according to the host country’s regulations and rules. It is mandatory for project officials to fulfill the tax, rebates, and subsidies, etc.
  • Off Takers: Refers to abound through an off-take contract that makes it compulsory to buy some minimum quantity of product from the selling side. In construction, mining, and other industries off-take agreement is mostly utilized.
  • Contractures & Supplier: For the implementation and accomplishment of the project contractors and suppliers play a significant role in the construction tasks. They supply the raw material for mass construction activities. Contractors also perform key functions such as maintenance, designing & building (D&B), and operations, etc.
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Advantages of Project Finance (PF)

The main advantage of project finance is the allotment of effective debt. PF allows the financers to raise the capital over the volume of parents. The terms & conditions of finance are beneficial and flexible that can be negotiated on the basis of merit.

The one thing that makes these big industrial projects special is due to risk management factors. This gives many diversifications and risk dilution. The parent corporate investors are secured against variation in the fate of the project.  It also illustrates the economy of scale when two corporations agree to work together for achieving common goals.   

Project finance is based on non-resource financing in which the loan taker & shareholders of the debtor does not bear any penalty in case of money default.  It involves multiple countries for project agreement which generate stable returns that eventually lead to the betterment of the world’s economy.

Limitation of Project Finance

Project finance is a complex process because it is dependent on numerous agreements among multiples parties such as technical advisors, equity investors, insurance providers, export credit agencies, equipment suppliers, lenders, and off-takers, etc.

When so many groups of people are involved the negotiation phases also become composite. It also becomes hard to manage the flow of transactions between the stakeholders.

The documentation phase is a bit expensive and time-consuming. As the special purpose vehicle has legal status therefore financial institutes do recovery against SPV cash flow and assets. Due to many legal formalities between countries, this project becomes stressful for the sponsors.

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Constant expert assistance is required throughout the project due to the complex setup, transaction, and large number of parties. Availing the professional services and conducting of industrial, public utilities, and long-term infrastructure business incurs huge capital.

Sometimes finance partners do not understand the new business structures and arrangements that may lead to project failure.

Conclusion

Project Finance is the most popular method in the industrial segment to do funding in public utility & public infrastructure. Professional stakeholders are involved in this whole process for the funding for large projects. It is important to reach out to efficient investors to fulfill financial needs.

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