What is project finance? It’s the most common question in the industry yet it’s difficult to answer because there is no consensus definition of project finance. Worse still, many of the most often used definitions of project financing aren’t in agreement. Despite the lack of a consensus definition of project finance, there is almost universal agreement on the features of project finance that are common in every project financing. Because there are numerous features of project finance present in all project financings, we look to those features of project finance to provide context to our clients and visitors. Identifying the features of project finance which are common to all project financings is important to understanding project financing. If the financing you seek for your project includes all of the features highlighted below it is a virtual certainty that project finance is the course you should pursue to finance your deal.
Features 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 $230 billion in project finance loans being originated annually, the industry still doesn’t agree on a consensus definition of project finance. Despite almost universal disagreement over the definition of project finance, there is almost universal agreement on the features of project finance that are common in every project financing and they are listed below.
The most visible characteristic of project finance is that it is non-recourse debt as to individual shareholders, including the project sponsors. Non-recourse financing means the borrowers and shareholders of the borrower 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 primarily or entirely to the project assets (including completion and performance guarantees and bonds) if the project company defaults on the debt. The special purpose entity project company is formed for the express purpose of owning the project. The project company has no credit or assets so project 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. In extreme cases, if the project lender is not satisfied with the ability of the project to repay the loan, the lender may require some level of limited recourse from the sponsors or investors.
Off-Balance Sheet Financing
Another very visible element of project finance is that it is off-balance-sheet financing. In project finance transactions, the owner of the project, known as the project company, 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 any one 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 feature of project finance is attractive to project sponsors and participants alike because project loans do not load their balance sheets with debt, 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.
A far 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 2017-2018 was almost $750 million. While Moneymec assist to provides project financing of at least $20 million, project financings typically involve amounts ranging $10 million to more than one billion dollars. Think infrastructure projects primarily in developing countries.
Numerous Project Participants
Another feature of project financings is that they always involve numerous project participants. The vast amounts which are typically involved in project financings often make it necessary for project sponsors to add equity investors to the list of project stakeholders. In the case of large projects, project finance providers like Moneymec frequently become the lead provider or lead arranger of the financing, spreading the work responsibilities, profit and most importantly the risk among several financiers. Similarly, project loans for big projects are often too large for one lender to provide. When a project loan amount would represent too high a percentage of a lender’s capital the lender frequently assumes the role of lead lender in a a consortium of lenders and lays-off a portion of the loan to other institutions. Financial institutions never want to be in a position where the failure of one project or one borrower to be large enough to cause their own failure. In addition to multiple financiers, lenders and investors, project financings include a lengthy list of professional stakeholders which includes consultants, suppliers, offtakers and contractors so it is not uncommon for there to be twenty or more key project participants.
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.
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 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.
Special Purpose Entities And Finite Life
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.
Cost of Financing
One of the most common features of project financings is the cost which is generally more expensive than typical corporate financing options. Additionally, project finance frequently involves the use of highly-specialized financial structures which drives costs higher and liquidity lower. The cost of underwriting a project financing is significantly higher than is any other field of finance. With the difficulty associated with placing project finance loans, the complexity of originating and structuring specialized financing structures, the substantial work that goes into underwriting project financings end the enormity of conceiving and drafting project documents, project financings involve more time and more work than other methods of financing by an order of magnitude. Thus, Project Finance costs substantially more than other forms of financing. Pricing of project financings may be even higher still depending on the cost country because costs are driven higher by premiums for emerging market risk and political risks. Emerging market political risk insurance is commonly factored into overall costs.