Project Finance Features Overview
A more expensive financing structure, not here
The most visible characteristic of project finance is that it is non-recourse
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.
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 was almost $750 million. While Brainchild Property Group, INC provides project financing of at least $5 million, project financings typically involve amounts ranging $50 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 many, many participants. Beginning with the project sponsors, the vast amounts involved in project finance usually require equity investors, project finance providers like Brainchild Property Group, INC, 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 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. 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.
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.
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 Financing
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.