Project Financing refers to financing of long-term projects such as those involving real estate projects or setting up manufacturing units. A project financing loan is repaid from the cash flow generated after the project implementation is complete and the production operations start yielding revenue. Project financing is generally a non-recourse or limited recourse financial structure.
Project financing is usually required for a high capital intensive, and long-lasting industrial initiative where assets are given as collateral to the creditor as the only source, together with the cash flow generated by the project for debt service repayment. So, to bridge the distance between sponsors and lenders, an intermediary is created i.e. special purpose vehicle (SPV). The main function of the SPV is to oversee the fund procurement and control to ensure that the project assets do not succumb to the aftereffects of task failure. Before a lender decides to finance a task, it is also crucial that each risk that would affect the project is identified and planned for just to avoid any future problem.
Key attributes of project financing are listed as below:
- Capital intensive
- Risk assessment
- Multiple participants applicable
- Asset ownership is decided after project completion
- Zero or limited recourse financing solution
- Loan repayment with project cash flow
- Better tax treatment
- Sponsor credit has no impact on the project
Stages of Project Financing:
- Pre financing stage
- Financing stage
- Post financing stage
This is the first stage in project financing where the borrower has to plan, identify, assess, and then strategize the project feasibility. As the borrower has to identify the project plan, how will it work, what are the pros and cons, how much loan is needed, what are the assets or liabilities, how much time will he need to refund the amount, and most importantly, to ascertain the project feasibility or what will be the outcome of the project before applying for the financing. One has to check the availability of the assets and resources to avoid any kind of future risks.
Next comes the financing stage, which is the most critical one as it is the time to get into action. To take care of the finances, one has to approach and find the right sponsor or financer for the project. Then the borrower and the lender have to negotiate and come to a decision with both the parties agreeing on the same platform for the financing. Once the decision is final, documentation comes into picture. The terms and conditions of the loan are mutually decided and documented meticulously. After completing the documentation process including the verification, the loan amount is handed over to the borrower for carrying out the operations of the business.
When the financing stage is over, the borrower has to keep track of the project so that it gets completed in a stipulated time frame. Once the project is over, it is time for the repayment of the borrowed amount. The borrower has to keep track of all the cash flow from its operations since these funds will be utilized to repay the loan amount.
For a deeper understanding of project financing and guidance on when and how to go for it, get in touch with the Capital 9 team.