Project financing involves financing capital-intensive projects like energy, infrastructure, health care, construction, telecommunication, etc. These projects involve long term off- balance sheet investments using non-recourse financing solutions. Project finance is funded by a mix of equity, debt and loans, commonly known as Special Purpose Vehicle (SPV). The investors of a project are usually referred to as sponsors. They are usually institutional investors who will invest a sizable amount and have a fairly huge risk appetite.
Project financing considers each project as a unique item and the debt, equity and loan invested into the project are repaid from the cash generated by the project itself. The assets and securities assigned to the project can be used as collateral only for loan financing. Thus, project financing is a very lucrative investment option for big investors.
Though every project carries varied risks and returns, it is difficult to identify all the features of project financing. However, based on the definitions and methods some common features of project financing that are applicable to projects across varied industries are:
Non- recourse financing structure:
In case of a monetary default, the sponsors of project finance have no personal liability. The project financing company is a limited liability SPV, so the sponsors will not make good any losses to the lenders in the event of a default. The lender’s risk is minimized or limited to the use of project’s assets as a collateral to cover the risk of default.
Off- Balance sheet item:
If an existing company invests in a new project, it is not reported as a balance sheet item. Since the project cash flows alone can be used for payments of its debts, equity, liabilities and expenses, it does not appear in the balance sheet of the primary company. An important reason for being an off- balance sheet item is the non-recourse nature of project financing.
Debt and loans form a major part of the project’s capital structure. This provides the sponsor with high leverage, as their funds are at a limited risk because of non-recourse financing. Sponsors’ credit rating is not affected because of the project’s performance. This gives the sponsor a significant advantage. The sponsor can finance the project without diluting their equity and can offer capital at a lower cost.
Improved tax benefits:
Project financing, being a long-term investment, helps to structure the financing and get various benefits, including government grants, low interest rate loans, tax credits, etc. There are provisions in the Income Tax Act, where incomes pertaining to particular projects can be deducted or do not form a part of total income. This helps the projects to gain a competitive advantage and perform better by using various tax treatments.
As project finance involves large investments, a single sponsor may not meet the capital requirement. Having multiple sponsors and lenders dilutes the risk in case of project failure. Multiple participants take care of different aspects of project financing, which helps in regulating finances and streamlining the work responsibilities and functioning.
The development of project financing follows 3 main stages:
Pre- financing stage:
This is the first step of financing, which involves the project to be minutely analyzed to identify both the risks and the payoffs. An entire feasibility study is done to assess the project’s viability viz-a-viz various factors, including:
- technical feasibility,
- environmental-social-political feasibility,
- legal issues, etc.
This preliminary stage is very crucial to estimate the project risks and ensure that it meets the business needs. This stage also involves estimating the capital requirement along with the debt -equity mix ratio to bring the project from start to completion.
In this stage, the sponsors approach various financial institutions, investors and loan providers with the project feasibility studies to get the required funds. The sponsors negotiate all the terms and conditions and agree with the parties providing finance. All documentation and verification are done at this stage, including the disbursement of funds as per the agreements.
Post- financing stage:
This is the last stage, which involves monitoring the movement and use of funds. Each stage of the project is carefully scrutinized to ensure that the funds are used for the said purposes and all stages are completed within the set deadlines. Once the project is successfully completed, the liabilities and debts have to be settled as per the agreement.
The demand for project financing in India has been witnessing a steady rise, especially with the government introducing various developmental projects. Project financing demands huge expertise in both investing and financing. Diligen is one such financial service provider specializing in project financing. Their team of dedicated professionals and experts has in-depth knowledge in project financing across various sectors. If you are looking for someone to make project financing easy for you, then get in touch with the experts at Diligen now.