Project advisory services falls under one of the core branches of corporate advisory services. It deals with the decision of financing a project based on its strength of assuring the future cash inflows. In other words Project financing deals with financing a project, which can in turn generate return for its stakeholders and help in repaying the interest and loan on the proposed project. The assets used for undertaking that project are used as collateral for financing that project.
The following constitute the differences between project financing and the other types.
- In project financing, the lenders look at the strength of the project to perform and generate sufficient returns to serve the interest and loan on that project. Even if the assets are taken as collateral, they may not be able to cover the entire loan through the sale of assets. Hence the lenders mainly look about the profitability of the project. Where as in asset financing, the lenders are mainly interested in the value of the asset if sold.
- The level of risk for the lender in financing a project can fall under both business risk and financing risk. Business risk is the one that is associated with the business of the borrower and the financing risk is the risk of financing that particular borrower. Where as if we talk about asset financing, the risk involved is only up to financing risk.
- The risk of financing a project is more, as the project has to be analyzed even before testing the market. The amount financed will be totally utilized in running the project and then the risk will totally be dependent on the profitability of the project.
The process of project financing starts from the very initial stage of analyzing the project and then moving on to the requirements of lenders, the statutory provisions, the sponsors and other investing parties in the project and finally ends at the repayment of the long-term borrowings related to it.
Various Components that aid the Project Financing Process
The following components take care of the financing process.
- Project Conceptualization: The main requirement of financing depends on the concept of the project, the business opportunity for it in the market and also the revenue model. Convincing the lenders for financing a project becomes comparatively easy if the project is not first of its kind. If the project uses a technology that is already in use and perceives profitability it becomes easier to convince the lenders. The project should also satisfy the policy requirements of the government, the lending institutions and the banks
- Project Structuring: Project structuring focuses on reducing the risks associated with the project in areas like location, operational, production and distribution, technology identification, marketing issues and the promoter resourcefulness.
- Project Consortium: A strong project consortium helps in reducing the time required to achieve the financial closures of the project. Depending on the nature and size of the project, the consortium may consist of the combination of project sponsors, technology providers, suppliers, contractors and various other investors.
- Key Project Contracts: These are the contracts that should be kept ready before the company enters in to any of the financial contracts. Some of the key project contracts in infrastructure and other projects consist of shareholders agreement, license agreement, EPC (Equipment procurement and construction contractors) contract, operations and maintenance agreement, product buy back or usage agreement, foreign collaboration and technology transfer agreement, joint venture agreements etc.
Major Project Financing Options
The major options available are as follows
- Project financing through long term debts
- Project financing through equity
1. Project financing through long-term debt
Project financing through long term debts takes three forms. They are
- Domestic rupee term loans: The project can be financed by short term or long-term loans from domestic financial institutions and commercial banks. They can finance the project through rupee loans or the foreign currency loans and guarantees. These loans can be either fixed interest rate or floating interest rate pegged to some benchmark rate.
- External commercial borrowings: Loans raised for financing a project from outside India are called as external commercial borrowing. These borrowings are named so because they also add to the external debt of the country.
- Debentures and other debt securities: In some cases, the project can be financed through debentures, bonds and other debt securities. The projects can make use of private institutional investors or IPOs for getting the debentures and other debt securities
2. Project financing through equity
The main source of equity for a project will be its promoters. Other sources include consortium partners, investors, collaborators, JV partners, and institutional buyers.
External Links:
- Project Finance — Key Concepts (World Bank)
- Project Finance (European Investment Bank)