Understanding Project Financing 

Project finance is the financing of long-term infrastructure, industrial projects and public services based upon a non-recourse or limited recourse financial structure, in which project debt and equity used to finance the project are paid back from the cash flow generated by the project. Project financing is a loan structure that relies primarily on the project's cash flow for repayment, with the project's assets, rights and interests held as secondary security or collateral. Project finance is especially attractive to the private sector because companies can fund major projects off balance sheet.

Project Finance can be characterized in a variety of ways and there is no universally adopted definition but as a financing technique, a broad definition is:

“the raising of finance on a Limited Recourse basis, for the purposes of developing a large capital- intensive infrastructure project, where the borrower is a special purpose vehicle and repayment of the financing by the borrower will be dependent on the internally generated cashflows of the project”

This definition in itself raises a number of interesting questions, including:

1. What is meant by ‘Limited Recourse’ financing – recourse to whom or what?

2. Why is Project Finance typically used to finance large capital intensive infrastructure projects?

3. Why is the borrower a special purpose vehicle (SPV) under a project financing?

4. What happens if the internally generated cashflows of the project are not sufficient to repay the financiers of the project?

The terms ‘Project Finance’ and ‘Limited Recourse Finance’ are typically used interchangeably and should be viewed as one in the same. Indeed, it is debatable the extent to which a financing where the Lenders have significant collateral with (or other form of contractual remedy against) the project shareholders of the borrower can be truly regarded as a project financing. The ‘limited’ recourse that financiers have to a project’s shareholders in a true project financing is a major motivation for corporates adopting this approach to infrastructure investment.Project financing is largely an exercise in the equitable allocation of a project’s risks between the various stakeholders of the project. Indeed, the genesis of the financing technique can be traced back to this principle. Roman and Greek merchants used project financing techniques in order to share the risks inherent to maritime trading. A loan would be advanced to a shipping merchant on the agreement that such loan would be repaid only through the sale of cargo brought back by the voyage (i.e. the financing would be repaid by the ‘internally generated cashflows of the project’, to use modern project financing terminology).

A simplified project financing structure for a build, operate and transfer (BOT) project includes multiple key elements:

A special purpose company/vehicle (SPC/SPV) project company with no previous business or record is necessary for project financing. The company’s sole activity is carrying out the project by subcontracting most aspects through construction contract and operations contract. Because there is no revenue stream during the construction phase of new-build projects, debt service is possible during the operations phase only. For this reason, parties take significant risks during the construction phase. Sole revenue stream is most likely under an off-take or power purchase agreement. Because there is limited or no recourse to the project’s sponsors, company shareholders are typically liable up to the extent of their shareholdings. The project remains off-balance-sheet for the sponsors and for the government.

There are multiple parties involved in a typical project and there are multiple configurations of the “capital stack” used to finance the development, construction and operations during the project’s life. In contrast, corporate finance is carried out by the corporation as a whole rather than by an entity created specifically to hold ownership of the new facility. Lenders in a corporate financing agreement evaluate the cash flow and assets of the entire corporation to service the debt and provide risk mitigation.

An alternative to corporate financing is the formation of a project company to develop, construct and operate a plant or facility. In a project financing, investments in the plant are considered assets of the project company, and funding is provided in the form of equity, debt or a combination of the two. The project’s assets and cash flow secure the debt, and creditors do not have recourse to the sponsors’ other available resources.

This type of borrowing is called non-recourse. Since the repayment of the loan is primarily dependent on the success of the project, lenders pay special attention to project risks and risk mitigation.

Loan Origination is the process of assembling a project package that describes how funding is organized  in the form of equity and how much in debt. Equity is put into the project company by shareholders who then receive dividends and capital gains based on net profits of the project company.

Project debt refers to the funds loaned by lenders such as commercial banks, insurance and pension funds and multilateral institutions. These loans are secured by the project’s assets and the lenders receive payments for principal and interest whether the company is profitable or not. Debt lenders examine projected cash flow carefully to insure there is sufficient financial capacity for debt service and repayment.

To raise project funding, sponsors issue or sell securities which represent a claim on the future cash flow of the project and a contingent claim on the assets of the project.

The type of security determines the order in claim of the debts over the cash flow and the assets of the project. Senior debt ranks highest and are normally in the form of loans from commercial banks, investment banks, development agencies, pension funds and export credit agencies.

Next in order comes subordinated debt which is a second claim on the assets of the project. Subordinated debt is assumed by lenders willing to take greater risks, and they can in turn, receive greater returns on their investment.

Equity involves the highest risk and can be contributed by project sponsors, investment funds or multilateral institutions. Public equity is an option and can come from governments or a host of lending agencies such as the World Bank, regional banks, export credit or trade agencies.

Financial flows in any project can be categorized as public and/or private. Public flows include technical assistance, loan guarantees and borrowing from multilateral agencies under government sponsorship.

Private flows include debt and equity:

1. Debt includes bonds and bank borrowing

2. Equity includes foreign direct investment or portfolio equity
   

Challenges of Project Financing in Emerging and Frontier Markets

Structuring financial packages can be difficult in emerging markets.

1. Many emerging markets have limited domestic resources including capital, skilled labor. raw materials and infrastructure.

2. Because of these shortages, investors will rely on foreign capital and resources not available locally.

3. To acquire these resources, investors must be convinces that these resources will be utilized efficiently and profitably and that returns on investments can be repatriated according to known rules and regulations.

4. These concerns are directly related to the host country’s business environment, political and economic stability and regulatory systems. Weaknesses in the host country’s business environment increases risks and decreases the probability of investment.

Stakeholders In Project Financing

Sponsors
The equity investors and owners of the Project Company can be a single party or a consortium of sponsors.
Subsidiaries of the sponsors may also act as sub-contractors, feedstock providers, or off-takers to the Project Company.
In PPP projects, the Government/Procurer may also retain an ownership stake in the project and therefore also be a sponsor.

Procurer
Only relevant for PPP – the Procurer will be the municipality, council or department of state responsible for tendering the project to the private sector, running the tender competition, evaluating the proposals and selecting the preferred sponsor consortium to implement the project.

Government
The government may contractually provide a number of undertakings to the Project Company, Sponsors or Lenders which may include credit support in respect of the Procurer’s payment obligations (real or contingent) under a concession agreement.

Contractors
The substantive performance obligations of the Project Company to construct and operate the project will usually be done through engineering procurement and construction (EPC) and operations and maintenance (O&M) contracts respectively.

Feedstock providers and Offtakers

1. Typically found in utility, industrial, oil and gas and petrochemical projects.

2. One of the parties will be contractually obligated to provide feedstock (raw materials or fuel) to the project in return for payment.

3. One of the parties will be contractually obligated to offtake / purchase some or all of the product or service produced by the project.

4. Feedstock/Offtake contracts are typically a key area of lender due diligence given their critical role in the overall economics of the project.

Lenders
Typically including one of more commercial banks and/or multilateral agencies, export credit agencies or bond holders.

Stakeholder motivations for project financing
Project financing is predicated on the equitable allocation of risks between a project’s stakeholders through various contractual relationships between the parties. A well structured project provides a number of compelling reasons for stakeholders to undertake project financing as a method of infrastructure investment.

Sponsors
In a project financing, because the Project Company is set up as a special purpose vehicle (or SPV), the liabilities and obligations associated with the project are one step removed from the sponsors. This provides a number of structural advantages to the sponsors:

1. Limited Recourse: A default under a corporate loan may enable the lender recourse to the assets of the company. In a project financing, a lender’s only recourse is to the assets of the Project Company. This is an important consideration given the magnitude of the financing for many infrastructure investments which may be far greater than the corporate balance sheets of the sponsor. Notwithstanding the above, it would be inaccurate to surmise that project financing is always non-recourse to the shareholders, as commonly other forms of support such as contingent equity and partial or full completion guarantees may be provided directly by the sponsors of the Project Company.

2. High leverage: A project financing is typically a highly leveraged transaction – it’s rare to see a Project Company financed with less than a 60/40 debt/equity ratio and in certain sectors such as social infrastructure, it’s not uncommon for projects to be 90% debt financed. The key advantages to sponsors of the high leverage include:

3. Lower initial equity requirements thereby making the project investment a less risky proposition

4. Enhanced shareholder equity returns

5. Debt finance interest may be deductible from profit before tax, thereby further reducing the weighted average cost of capital of the Project Company.

The advantages noted will all help to lower the cost of a project and therefore are desirable from both sponsor and Procurer perspectives. However lender covenants will invariably limit the extent to which sponsors can lever the Project Company. Moreover it is not uncommon in PPP programs for the host government to restrict the maximum permissible gearing for a Project Company in order to promote meaningful levels of foreign direct investment through equity shareholdings.

Balance sheet treatment: In a traditional corporate lending structure, the capacity of a corporation to raise debt financing is constrained by the strength of its balance sheet, commonly assessed by the prospective lenders through various financial performance ratios such as Net Debt/EBITDA. Project financing allows the shareholders to book debt off balance sheet, although the extent to which this is achievable will generally be determined on the basis of the extent to which the sponsor is determined to control the asset with reference to the specific shareholding structure of a project and the contractual term of the concession agreement.

Project financing also provides a vehicle for companies to hedge risks of their core businesses. Take the example of a power utility domiciled in a developed western nation with a domestic merchant power market supporting most of its generating assets. the attractions of investing in an emerging project financed IPP would include

Expanding the geographic footprint of its asset base, thereby diversifying the macro-economic / political portfolio risk and

Diversification of the risk profile of its revenue stream through, for example, securing a source of long term contracted revenues under a PPP framework to balance the market risk inherent to it’s domestic merchant portfolio.

Lenders
As with any form of financing, lenders to a project financing extract a return commensurate with the level of risk. In itself, this is a motivation for any form of lending. Lenders to a project financing also typically extract additional returns through the provision of the associated products and services required by the Project Company.

PROJECT FINANCING PROCEDURE 

​Here is the step by step project financing procedure for project promoters /sponsors seeking to raise capital for their projects before a Term Sheet can be issued by our Investor(s)/Financier(s):

1. The client shares the  Project Feasibility Study Report (FSR) along with the Detailed Project Report (DPR)/Business Plan & Project Financial Modelling Workbook with us for reviewing and evaluation by our project finance team. If we are satisfied after reviewing the details, we will send our Terms & Conditions for providing  Project Finance Services. 
   

2. Once the client accepts our Terms & Conditions, he signs and returns it to us.
   

3. The client remits our "Engagement Fee" to our nominated bank account. For Indian clients, our Engagement Fee is INR Ten Lakhs plus 18% GST and for clients overseas, our Engagement Fee is US$17,700.00. Upon receipt of our Engagement Fee, We enter into  a “CLIENT AGREEMENT” with the client and send to the client Project Finance Application Form for filling up. 
   

4. Overseas clients may fill up the PROJECT FINANCE APPLICATION FORM online which is accessible once our Engagement Fee of US$ 17,700.00 is paid and submits this form filled with all necessary information and supporting documentation required in the application form.
   

5. Once we receive the Project Finance Application Form duly filled, we send to the client our First Evaluation Report (FER) of the project. Depending on the FER, the client might be required to furnish additional information relating to his company and his project(s). If the Business Plan submitted by the client falls short of the industry standard, our team will assist the client by suggesting how to bring it to a standard widely accepted by investors/financiers. This assistance, however, is provided at an extra cost to the client and such cost is project specific. 
   

6. Several rounds of video conferencing between the client and our expert project finance team follows to finalize the Investor Pitch.
   

7. Once investors/financiers firm up, we, together with the project promoters finalize the securitization and risk structuring for them. Generally an LOI from the Investor/Financier precedes a  "Term Sheet", which is project specific (and hence there is no general format).
   

8. Upon acceptance of the Term Sheet by the client, a due diligence will be conducted by the investors/Financiers at their own costs (Please note, a big ticket investment/financing be brought to a financial close by a single investor/financier lone. In such a case, there will be multiple investors/financiers involved and we might undertake a Loan/Equity syndication process at an additional cost to the client.
   

9. Upon successful due diligence, the client will enter into the either a Joint Venture (JV) Agreement with investors or Loan Agreement(s) with individual lender(s) / Investor(s).
   

10. Joint Venture Company formation (Project Funding is always done in a SPV/SPC) or Loan disbursal will ensue as per the JV Agreements/Loan Agreements signed between parties.
    

Important To Note: 

1. We quickly respond to all inquiries. 

2. We do not delegate executive time to an inquiry until your project, as expressed in your fully completed Project Finance Application form, has been thoroughly evaluated by our analysts.

3. To ensure our executives do not waste time on unrealistic inquiries we do not enter discussions in any form until we have a full understanding of your project's potential and risks. We therefore do not offer meetings, hold telephone discussions or return telephone calls until we have thoroughly evaluated your project.

4. Please do not send us additional communications during the application phase as it delays the application process.

5. We do not finance projects valued at less than $5,000,000.00 (United States Dollars five million), we do not finance acquisitions and we don't finance projects in countries mentioned in this Restricted Nations list

6. All our official communications are in English. We do not offer a translation service.

Under the funding procedure, the Applicant may be asked to submit  the following (but not limited to) documents relating to the project that is seeking project finance:

1. Business Plan/ Pitch Deck

2. Project Financial Structure + Legal Structure + Management Structure

3. Revenue Model

4. Cash Flow Projections for the next five to ten years

5. SWOT Analysis of the project

6. Risk Analysis & Mitigation details 

7. SPV/SPC(Special Purpose Company/Vehicle) Registration documents

8. Federal and Local Government Departmental Clearances and Approval records

9. Environmental Clearances

10. Market Research Report

11. Feasibility/ Techno-Economic Evaluation Report (DFS/FSR)

12. Detailed Project Report (DPR)

13. Off Taker Agreements/ Contracts /PPAs

14. Procurement Agreements / Contracts supported by Equipment specs and Proforma Invoices

15. EPC Agreements / Contracts (with companies that will construct the project infrastructure)

16. Operations & Maintenance (O&M) Agreements / Contracts

17. Debt Exposure Details

18. Patents or Copyright certificates (If any)

19. Project Land Status and records including ownership/lease records

20. Legal Report (Establishing non-criminality) 

Financial Due Diligence
Financial due diligence requires that, during loan preparation and processing, sufficient analysis is undertaken to enable an informed assessment to be made with respect to project financial viability and long-term sustainability, and that the borrowers’ financial and project management systems are, or will be, sufficiently robust to ensure that funds are used for the purpose intended and that controls will be in place to support monitoring and supervision of the project.

There are Guidelines that provide the framework for financial due diligence, namely completion of a financial management assessment (FMA) of the executing agency (EA) and/or implementing agency (IA), financial evaluation of the project, and assessment of implementation arrangements (from a financial perspective, including disbursement and auditing arrangements).

The methodology note provides specific guidance in four primary aspects of financial due diligence:

1. financial management assessment,

2. project cost estimates and financing plan,

3. financial analysis, and

4. financial evaluation.

It also provides guidance on assessing disbursement auditing arrangements. This financial due diligence methodology note offers a suggested approach for operationalizing the standard project preparation and loan processing requirements of the Guidelines. the Guidelines, together with the methodology note, should be seen as a reference guide to assist staff in conducting an appropriate degree of financial due diligence during project  preparation and processing, and should guide staff in determining the appropriate level of financial management  safeguards required for a given project and/or EA and/or IA. The advice, directions, and recommendations provided should not be regarded as a substitute for the professional judgment of SUBCON staff.

Financial Management Assessment
Effective financial management within the EA and/or IA is a critical success factor for project sustainability, both in the effective use of funds and in the safeguard of assets once created. Irrespective of how well a particular project or program is designed and implemented, if the EA and/or IA does not have the capacity to effectively manage its financial resources, the benefits of the project are unlikely to be sustainable.
The objective of the financial management assessment (FMA) is to ensure that the EA and/or IA has, or will have, sufficiently strong and robust financial management systems and procedures in place to ensure sustainability of project investments and benefits over time.
The FMA is a review of the entity’s systems for financial and management accounting, reporting, auditing, and internal controls. It also involves an assessment of the entity’s disbursement and cash flow management arrangements, and governance and anticorruption measures. The FMA is not an audit; it is a review designed to determine whether or not the entity’s financial management arrangements are sufficient for the purposes of project implementation.

Approach and Methodology
The first step is to determine whether an FMA has recently been completed by any other credible financial institution (Bank, NBFC, VC or PE agencies) , the objective being to avoid duplicating diagnostic work that already exists. If an FMA exists, this should be reviewed and, in particular, any work done to overcome previously identified weaknesses should be checked. The original FMA can then be updated accordingly.
While planning to rely on the work of another lender , SUBCONTRACTS INDIA would thoroughly review the agency’s assessment report to determine whether or not the results of the FMA are reasonable and can be accepted by SUBCONTRACTS INDIA.
If an FMA has never been completed, or if there have been significant on-ground changes which render an existing FMA obsolete, then the following approach to the FMA is recommended:
Review the Economic Sector diagnostic studies specific to the country where the project is located, including the country financial accountability assessment, country procurement assessment report, country governance assessment, and diagnostic study on accounting and auditing.
Early in project preparation, have the borrower/project promoter complete a Financial Management Assessment Questionnaire (FMAQ).
Review responses to the FMAQ, determine what (if any) additional information is required in order to be able to conclude whether or not the financial management arrangements (a) are capable of recording all transactions and balances, (b) support the preparation of regular and reliable financial statements, (c) safeguard the entity’s assets, and (d) are subject to audit.
Review past audit reports and audit management letters to assess what concerns have previously been raised on systems and internal controls.
Form a conclusion with respect to whether or not the financial management arrangements and financial and project accounting systems can be relied upon for the purposes of the project.
If issues and/or weaknesses are identified, determine the most appropriate mitigation measures (e.g., restructuring finance sections, increasing finance staff, filling vacant posts, developing new systems, developing financial reporting, training, etc.).
Determine whether, given the findings, it is necessary to include a project component to strengthen financial management in the EA and/or IA and/or establish or strengthen a project implementation or project management office via either technical assistance or consultant support within the project.

Due Diligence
Due Diligence service is rendered by an accredited Due Diligence service provider appointed by the Funding Partner Company. Due Diligence is by far the most important exercise in the funding consideration process.

The charges for the Due Diligence are to be borne by the applicant. These charges are specific for every case and the applicant is given prior notice of this.
It is extremely important that the applicant understands clearly the processes of Due Diligence is to secure a successful transaction and mutual business relationship between the applicant and the Funding Partner Company.
The Funding Partner Companies provide finance to viable projects on precise terms. There are no general terms. Everything is specific to the project under consideration.

Once the Due Diligence is successfully completed, a Funding Offer is officially made from Funding Partner Company to the applicant (Project Owner(s)/ Promoter(s)). The Project Owner(s)/Promoter(s) are issued an Invitation Letter for a table meeting in the Funding Partner Company’s office which can be in any country. Post a personal interview of the project owner(s)/promoter(s) ,the MOU/Loan Agreement is drafted and signed. Insurance requirements too would be discussed and finalized at this meeting.

Post successful completion of all of the above processes, funding disbursement would commence within the specified time frame .

Please note our project funding services DO NOT come free and we are rather choosy about who we serve. We encourage only serious clients who understand what it takes to arrange finances for businesses. Our seamless services start with our client sending us a formal Letter of Intent expressing his/her desire to hire our services and then following this up with entering into a formal service agreement with us and depositing the token Engagement Fee which is non refundable. That is not all. You would be further liable to pay a Success Fee (case specific) post successful closure of funding. ​