Project finance is the financing of long-term infrastructure and industrial projects based upon a complex financial structure where project debt and equity are used to finance the project, rather than the balance sheets of project sponsors.
Usually, a project financing structure involves a number of equity investors, known as sponsors, as well as a syndicate of banks that provide loans to the operation. The loans are most commonly non-recourse loans, which are secured by the project assets and paid entirely from project cash flow, rather than from the general assets or creditworthiness of the project sponsors, a decision in part supported by financial modeling.
The financing is typically secured by all of the project assets, including the revenue-producing contracts. Project lenders are given a lien on all of these assets, and are able to assume control of a project if the project company has difficulties complying with the loan terms.
Generally, a special purpose entity is created for each project, thereby shielding other assets owned by a project sponsor from the detrimental effects of a project failure. As a special purpose entity, the project company has no assets other than the project.
Capital contribution commitments by the owners of the project company are sometimes necessary to ensure that the project is financially sound. Project finance is often more complicated than alternative financing methods.
Traditionally, project financing has been most commonly used in the mining, transportation, telecommunication and public utility industries. More recently, particularly in Europe, project financing principles have been applied to public infrastructure under public-private partnerships (PPP) or, in the UK, Private Finance Initiative (PFI) transactions.
Risk identification and allocation is a key component of project finance. A project may be subject to a number of technical, environmental, economic and political risks, particularly in developing countries and emerging markets.
Financial institutions and project sponsors may conclude that the risks inherent in project development and operation are unacceptable (unfinanceable). To cope with these risks, project sponsors in these industries (such as power plants or railway lines) are generally completed by a number of specialist companies operating in a contractual network with each other that allocates risk in a way that allows financing to take place.
The various patterns of implementation are sometimes referred to as "project delivery methods." The financing of these projects must also be distributed among multiple parties, so as to distribute the risk associated with the project while simultaneously ensuring profits for each party involved.
A riskier or more expensive project may require limited recourse financing secured by a surety from sponsors. A complex project finance structure may incorporate corporate finance, securitization, options, insurance provisions or other types of collateral enhancement to mitigate unallocated risk.
Project finance shares many characteristics with maritime finance and aircraft finance; however, the latter two are more specialized fields.
Specimen: The BOT (Build, Operate and Transfer)
Extract from Wikipedia, the free encyclopedia