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Elements of Project Finance2022-09-06T18:49:45-04:00

Elements of Project Finance

Common Elements of Project Finance Deals

Elements of project finance are common features and characteristics found in all project financings. We outline key elements and emphasize those which are common to all project financings.

Elements of Project Finance Overview

What is project finance? It’s the most common question in the industry yet it’s difficult to answer because there is no universally accepted definition of project finance. Worse still, many widely used definitions of project financing aren’t in agreement. Because there are numerous elements of project finance common to all project financings, we look to those elements of project finance to provide context.

Identifying the common elements of project finance is a worthy exercise to determine if project finance is really the best type of financing for your deal. If you cannot envision all of these elements of project financing being part of your deal, project finance is not the right financing. In the alternative, you should consider trade finance, contract finance, monetization or traditional corporate finance.

Common Elements of Project Finance

Project finance is the financing of large international projects like public infrastructure and public utility projects. But there is no single definition of project finance. Despite more than $350 billion in project finance loans being originated annually, the industry still doesn’t agree on a consensus definition of project finance. Despite widespread disagreement over the definition of project finance, there is widespread agreement on the elements of project finance. The listed elements of project financings are common in every project finance transaction.

Project Financings Are Capital-Intensive

A less visible element of project finance is that it involves huge amounts of financing because it is used to finance major international development and infrastructure projects. According to Project Finance International, the average project financing in 2017 was almost $750 million. While Global Trade Funding provides project financing of at least $20 million, project financings typically involve amounts ranging $50 million to more than one billion dollars. Think infrastructure projects primarily in developing countries.

Project Financings Have Numerous Participants

Another feature of project financings is that they always involve many, many participants. Beginning with the project sponsors, the vast amounts involved in project finance usually require equity investors, project finance providers like Global Trade Funding, project lenders which frequently become a consortium of lenders, to share the risk, and so on.  Review our Project Finance Learning Center for extended information about the project participants and stakeholders.

Project Financings Are Non-Recourse

Project finance is either non-recourse or very limited recourse as to individual shareholders, including the project sponsors. Non-recourse financing means the borrowers have no personal liability in the event of monetary default. Project companies are generally limited liability special purpose entities, so any recourse the lender may have will be limited to the project assets if the project defaults on the debt.

The project is owned by a special purpose entity which is formed for the express purpose of owning the project. The project company has no credit or assets so lenders don’t evaluate the project company when underwriting the project. Because project loans are non-recourse and the borrowers have no assets to satisfy deficiencies in the event of project default, underwriting is focused entirely on the viability of the project.

Project Financings Are Off-Balance Sheet

Project finance is off-balance-sheet financing. In project finance transactions, the project company that owns the project is a stand-alone company known as a special purpose entity. Because there are numerous participants and stakeholders in the project and ownership of the projected is a Special Purpose Entity, the ownership interest of the project sponsor or other project participant is a sufficiently minority subsidiary interest. As such the balance sheet of the project company is not consolidated onto the balance sheets of the project sponsors or shareholders.

The off-balance-sheet element of project finance is attractive to project sponsors because project loans do not negatively impact the sponsor’s balance sheet, nor does it impact their available borrowing capacity. Government entities also find the off-balance-sheet feature of project finance attractive because project debt and liabilities don’t impact their balance-sheets, relieving pressure on an increasingly stressed fiscal space.

Project Finance Documents

One of the most important features of project finance is the extent of project documents. Project financings are so complex, involve such vast amounts and so many participants, projects necessarily must also involve extensive, complex project finance documents if they are to be successful. Well-organized, well-written project documents are an absolute requirement of project financings. Because project finance documents play such an important role in project finance we have prepared a Project Finance Document summary with a brief description of each of the typical project documents.

Project Financings Allocate Risk

International project financing transactions tend to be riskier than ordinary corporate finance deals. Because of the risk exposure, allocation of the risk in the deal is often critical for approval of the project finance loan.

Risk allocation, which is accomplished in the project documents, attempts to match risks and corresponding returns to the deal participants most capable of successfully managing them. For example, EPC Contracts, which are fixed-price, turnkey contracts for construction that include severe penalties for delays put the construction risk on the contractor instead on the SPE, the project sponsors or the lenders. Risks inherent in typical project financings and mitigating factors are covered in more detail below.

Project Financings Special Purpose Entities

Project ownership is ordinarily held in a single-asset, Special Purpose Entity (SPE) with a limited life (sometimes referred to as Special Purpose Vehicle or Special Purpose Company) formed for the express purpose of owning a project pursuant to a Project Finance transaction by the project sponsors. They own only the underlying deal itself. In many cases, the clearly defined conclusion of the project is the transfer of the SPE.

Project Financing Cash Flow Waterfall

Again, due to the SPE and non-recourse financing, loan documents will typically contain a contractual obligation to apply excess cash flow from the project to debt service. Thus, any excess cash flow applied in this manner will accelerate loan amortization and reduce the lender’s risk exposure.

Cost of Project Financings

One of the most common features of project finance is it is generally a more expensive financing structure than is typical corporate finance options. Further, project finance involves the use of highly-specialized financial structures which also drives costs higher and liquidity lower. Margins for project financings usually include premiums for emerging market risk and political risks because so many projects are located in high-risk countries. Emerging market political risk insurance is commonly factored into overall costs.

The Berenberg Bank is a private merchant bank located in Hamburg that was founded in 1590. They have been providing project finance loans for 429 years and is still owned by the founding family.

Project finance is the lending structure that has financed a great many of the massive infrastructure and sovereign projects in emerging market countries throughout the world.

Project Finance Learning Center

Project finance was first used in 1299 when an Italian merchant bank provided the project financing to finance the development of English silver mines. England repaid the Italian merchant bank who funded the project with the output from the mines. Project financing has been used to finance thousands of projects since those silver mines, including such notable projects as the Panama Canal and North Sea oil platforms. Our Project Finance Learning Center includes information we hope will improve understanding of this type of finance.

Elements of Project Finance Key Takeaways

Elements of project finance are important to understanding project financing because there is no consensus definition of project finance. Thus it is the elements of project finance that provide a framework for the financing and help define the industry.

You should always remember the elements of project finance common in all project financing. Project finance provides long-term, limited recourse or non-recourse loans used to finance large commercial, industrial, infrastructure, and sovereign projects throughout the world. The debt and repayment structure are based on the project finance model where projected cash flow of the project rather than the balance sheets of the project sponsor.

Project financings involve numerous equity participants, who can be project sponsors or equity investors, and a consortium of lenders that provide the project loan. Project finance loans are almost always non-recourse or limited recourse secured by the project assets and operations. Repayment of the loans occurs from project cash flow, not the assets or credit of the borrower. These are just some of the common elements of project finance.

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