Any business initiating a project has to focus on three stages for the development process that includes
- Contract Negotiation and
- Fundraising stage
Be it a small project, public services, long-term infrastructure or some big industrial project you need to source funds from a reliable resource. The sourcing of funds is an integral part of the entire process to initiate, implement and successfully run an undertaking. Many businesses generally prefer project financing in order to fund their project. So, let’s have a detailed idea of project financing.
What is Project financing?
If you are planning to start an infrastructure, public services or industrial project and need heavy funds then project financing is the right solution for you. It’s a long-term, zero or limited recourse financing solution for businesses. It is available for businesses who are ready to take a loan against the assets, rights and interests related to the concerned project. The repayment of the loan can be done as the cash flow starts generating through the project or once the project is complete. In case, the borrower fails to repay the loan as per the agreed terms by both the party, then the lender is authorized to take the complete control of the project.
Key Features of Project Financing
Since big projects deal with huge funding amount, you need to understand the structure of this project financing scheme. We have listed the key features:
Capital Intensive Financial Scheme: This type of scheme is usually implemented in developing countries because it contributes to the economic growth of the country. It is ideal for businesses requiring a huge amount of debt and equity. This type of financing is more expensive than other corporate loans. This scheme reduces liquidity and drives costs higher. Project under this scheme carries political risk and emerging market risk.
Risk Allocation: The risk associated with project financing is shifted towards the lender. Therefore, sponsors opt for this financing scheme as they can avoid some of the risks. On the other part, lenders get the flexibility to receive better profit margins with project financing.
Multiple Participants Applicable: Project financing is often considered for large-scale projects. It provides the flexibility to allocate numerous parties in the project, so that various aspects of the project are well taken care of. This helps in the smooth operation of the entire process.
Limited or Zero Recourse Financing Solution: Until the completion of the project, the borrower does have the ownership and so the lenders do not require much time in evaluating the credibility and assets of the borrower. Instead, the borrower can focus on the project feasibility. The financial services opt for limited recourse if it finds that the project is not able to generate enough cash flow so that the borrower can repay the loan.
Better Tax Treatment: With the implementation of project financing, the sponsors or the project can receive the benefits of better tax treatment. And so, this scheme is preferred by sponsors so that they can receive tax benefits in long term projects.
No Impact of Sponsor credit on the Project: While this financial solution maximizes the leverage of a project, it also makes sure that the sponsor’s credit standing has no impact on the project. Because of this, the credit risk of the project is better than the sponsor’ credit standings.
Various Stages of Project Financing
- Pre-Financing Stage: Includes the following segments
- Identification of the Project Plan
- Recognizing and Minimizing the risk
- Checking project possibility
2.Financing Stage: This is a crucial stage that is sub-categorized as:
- Arrangement of Finances
- Equity or Loan Negotiation
- Documentation and Verification
3.Post Financing Stage: It includes various aspects like:
- Timely project monitoring
- Project Closure
- Loan Repayment
Project Financing is one of the best financial schemes for long term projects as it offers better credit margins to the lenders. It also shifts some of the risk from the sponsors to the lenders.