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.
“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::
- What is meant by ‘Limited Recourse’ financing – recourse to whom or what?
- Why is Project Finance typically used to finance large capital intensive infrastructure projects?
- Why is the borrower a special purpose vehicle (SPV) under a project financing?
- 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).
What are the Documents Required to Avail Project Finance ?
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:
- Business Plan/ Pitch Deck
- Project Financial Structure
- Revenue Model
- Cash Flow Projections for the next five to ten years
- SWOT Analysis of the project
- Risk Mitigation details
- SPV/SPC(Special Purpose Company/Vehicle) Registration documents
- Federal and Local Government Departmental Clearances and Approval records
- Environmental Clearances
- Market Research Report
- Feasibility/ Techno-Economic Evaluation Report
- Detailed Project Report
- Off Taker Agreements/ Contracts /PPAs
- Procurement Agreements/ Contracts supported by Equipment specs and Proforma Invoices
- EPC Agreements/ Contracts (with companies that will construct the project infrastructure)
- Operations & Maintenance (O&M) Agreements / Contracts
- Debt Exposure
- Patents or Copyright certificates (If any)
- Project Land Status and records
- 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:
- financial management assessment,
- project cost estimates and financing plan,
- financial analysis, and
- 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.
Challenges of Project Financing in Emerging and Frontier Markets
Structuring financial packages can be difficult in emerging markets.
- Many emerging markets have limited domestic resources including capital, skilled labor. raw materials and infrastructure.
- Because of these shortages, investors will rely on foreign capital and resources not available locally.
- 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.
- 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.
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