PARTIES' 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 an 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, including:
- Limited Recourse. A default under a corporate loan may enable the lender ‘recourse’ to (i.e. seek remedy against) 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 may be far greater than the corporate balance sheets of the Sponsors. Notwithstanding the above, it would be inaccurate to assume that project financing is always non-recourse to the shareholders, as commonly other forms of support in the form of contingent equity and partial or full completion guarantees may be provided directly by the Sponsors to the Project Company.
- High leverage. A project financing is typically a highly leveraged transaction – it is 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 is not uncommon for projects to be 90% debt financed. The key advantages to Sponsors of this high leverage, include:
- Lower initial equity injection requirements, thereby making the project investment a less risky proposition;
- Enhanced shareholder equity returns; and
- Debt finance interest may be deductible from profit before tax (PBT), thereby further reducing the (post tax) weighted average cost of capital of the Project Company.
- Lower initial equity injection requirements, thereby making the project investment a less risky proposition;
- 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 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 terms of any concession agreement.
Host Government / Procuring Authority
Considerable advantages are presented to governments through adopting PPP frameworks as a method of infrastructure procurement:
- Fiscal optimization. Traditional methods of infrastructure procurement require the government finance construction. PPP transfers the financing responsibility to the private sector, thereby allowing the government to amortise the cost of the asset over the term of the concession. The amortisation period will depend on the tenor of the financing achievable for the asset but 20 year commercial facilities are not uncommon in certain sectors.
- Process efficiency. PPP has been shown as a way of eliminating inefficiencies from governmental infrastructure procurement, through tighter contracting and increased rigour of execution.
- Performance risk. Under a PPP relationship, the risks of constructing and operating the asset are passed to the private sector through the head and sub contracts and the private sectors Sponsors are heavily incentivised financially to ensure full asset performance.
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 (e.g. project accounts, trustee roles, hedging and advisory services).
The revenue stream can come from, either the users of the project or from the offtakers. Let's dig a little deeper in the next chapter.
Follow this link : User or Offtaker revenue stream?.
Follow this link to Summary.
Follow this link : User or Offtaker revenue stream?.
Follow this link to Summary.
In case you need more information, or are eager to get into the details of Project Finance, I recommend the following reads , that I personally bought as to create the summarized information of this Project Finance website (Amazon links) :
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