What is Project Finance?
Defining “modern” project finance is an increasingly difficult
task; there is no universally adopted definition. As project
financing has evolved, it has imported techniques and market
evolutions from other banking disciplines. One example of this
can be seen in the increase in the use (particularly in natural
resource-based projects) of completion guarantees and other
forms of sponsor support, which historically has not been a
feature of limited or non-recourse lending. Notwithstanding
this difficulty, definitions of project finance will generally focus
on the basic premise that:
■ a newly formed, often thinly capitalized, special purpose
vehicle (the project company) will own an asset (which
may at that time amount to little more than a collection of
licenses and contracts granting the project company the
right to develop and construct the project); and
■ that project company’s lenders will finance (in part) the
development and construction of the project on the basis
of their evaluation of the projected revenue-generating
the capability of the project.
There are key characteristics that are common to most project
financings:
■ the project is developed through a separate, and usually
single-purpose, financial and legal entity;
■ the debt of the project company is often completely separate
(at least for balance sheet purposes) from the sponsors’
direct obligations;
■ the sponsors seek to maximize the debt-to-equity leverage
of the project, and the amount of debt is linked directly to
the cash flow potential, and to a lesser extent the liquidation
value, of the project and its assets;
■ the sponsors’ guarantees (if any) to lenders generally do
not cover all the risks involved in the project;
■ project assets (including contracts with third parties) and
revenues are generally pledged as security for the lenders;
and
■ firm contractual commitments of various third parties
(such as construction contractors, fuel, and other feedstock
suppliers, purchasers of the project’s output, and government
authorities) represent significant components of the
credit support for the project.