Project finance is a  long term financing technique which is used for infrastructure projects. This essay is about why, how and under what circumstances project finance can be used. It also reviews the benefits and limitations of project finance.

Main body

Project finance refers to the financing technique which is used for long term industrial project, infrastructure and public services. It is used when there is non-recourse financial structure where the debt and equity of the project are paid back from the cash which is generated from the long term project. It refers to the loan structure which has repayment from the project’s cash flow. This is used when assets, rights and interests of the project could be used as the secondary collateral or security of the financing (Nevitt and Fabozzi, 2000). The key characteristics of this financing technique are non-recourse funding, complex contractual arrangement, variety of participants, off-balance sheet transaction allocation of risks, a range of financial instruments along with the rigorous revenue stream of the project (Yescombe, 2002). Usually, there are various equity investors (i.e. sponsors) and a syndicate of lending institutions (e.g. banks) which provide the loan to the project. These are non-recourse loans which has to be entirely repaid from the cash flow of project and these are secured by the assets of the project. Generally, it is mandatory to create a special purpose entity for managing such projects and this company has no assets other than the project. Project finance is commonly used in mining, telecommunication and transportation (Kleimeier and Megginson, 2000).

One example of project finance is of development of the North Sea Oilfields which was started during 1970s. This project was financed through this financing alternative. The benefit which was achieved in this project was that they became able to get the lucrative investment for their project, how the limitation was that the transaction cost increased significantly.Other than this, U.S. power market also relied on project finance (Esty and Matysiak, 2004). In U.K. Private Finance Initiative was being started in 1992 by British Government and since then it is managed in an effective manner by successive governments. This is a systematic program of project finance where public services are funded through partnership of private and government sector. Under the long term arrangement, contracts of projects are started and project company received a specific revenue stream during the life of specific project. In U.K. essential infrastructure like military accommodation, schools, street lighting and roads are developed under the project finance. The benefit achieved in this arrangement was its capability to raise a large amount of cash for essential infrastructure. Such large amount of cash could not be obtained through any other financing alternative. However, to manage this mechanism often seems complex to the managers (Gardner and Wright, 2010).

There are various benefits of project finance. According to Grimsey and Lewis (2007), this alternative of financing allows to raise a large amount of cash for the long term period. It also allows to raise debt capital and foreign equity for the projects. It provides protection to the balance sheet of project sponsor. With the help of proper risk allocation mechanism, sponsor is enabled to undertake the risk more than what it is willing to take independently. There is involvement of strong discipline for contracting operations and processes through the private sector participation and proper risk allocation (Esty, 2014). It is noteworthy to mention that rigid scrutiny is also applied on the capital investment decisions. There are various international players which are part of the contract hence the project has a de facto political insurance. It has the feature of finite life along with the fixed dividend policy, hence, the project managers take the decisions as project investors hence they reinvest the cash in the most efficient and effective manner (Yescombe, 2002).

On the other hand, project finance also involves few limitations. Though, it might seem simple but, in fact, it is a complex financing mechanism where there is a need for significant lead times. It is important to create the special purpose vehicles for this project and this creation of special purpose vehicles involve a high transaction costs. It involves elevated coverage ratios and high cash flow requirements. Under project finance technique, there exist intrusive supervisor from the management and this is considered resented in a corporate finance environment (Esty, 2014).

Conclusion

In this essay, it is concluded that project finance is one of the innovative techniques for financing the infrastructure projects. it is adopted for long term and non-recourse projects where repayment of syndicated loan is through the cash flows of the project. Though, this technique is quite beneficial but it also has certain limitations which should not be ignored.

References

Esty, B.C. and Matysiak, G.A., 2004. Modern project finance: A casebook. New York, NY: Wiley.

Esty, B., 2014. An Overview of Project Finance and Infrastructure Finance-2014 Update. HBS Case, (214083).

Gardner, D. and Wright, J., 2010. Project Finance, [Online], Available at: http://www-vh.hsbcnet.com/gbm/attachments/products-services/financing/project-finance.pdf [Accessed on: 12^th November, 2016]

Grimsey, D. and Lewis, M., 2007. Public private partnerships: The worldwide revolution in infrastructure provision and project finance. Edward Elgar Publishing.

Kleimeier, S. and Megginson, W.L., 2000. Are project finance loans different from other syndicated credits?. Journal of Applied Corporate Finance, 13(1), pp.75-87.

Nevitt, P.K. and Fabozzi, F.J., 2000. Project financing. Linnius.

Yescombe, E.R., 2002. Principles of project finance. Academic Press.