Project Finance deals with gathering of funds for financing an economically separable capital investment project. Here, the people who provide funds, basically keep their eyes on the cash flow from the project which for them is the source of fund to service their loans. This method of financing is more intricate and more costly as compared to the other financing methods. The fields where such a method of financing is used are mining, telecommunications, other public utility services all of which are constantly under a various number of risks. Therefore, it always requires a set of companies which work under a deal in a network.
Such financing is primarily used for long-term infrastructure and is a complicated financial structure. In such a finance structure, the debts of the project and equity used for financing it are all paid back from the cash flow obtained from the project instead of general assets which is normally the case under other financing methods.
With such high risk factors involved, even the financing is done in a typical manner involving more than one or several parties that invest simultaneously on the same project. This is to divide the risks associated with the project, while ensuring profits for all the financers, if the project is a success. Generally, in a project finance scheme a large number of equity investors are involved, called the sponsors. Also involved are a number of banks that provide loads for the project operations. The kinds of loans provided are primarily of two kinds:
1) Non-recourse loans
2) Limited recourse loans
Non-recourse loans are those that are protected by the project itself and are compensated entirely from the cash flow of the project. On the other hand, the limited recourse loans are protected by the sponsor’s guarantee. If the complexity of the project is more, then various other factors come in for security like insurance or even corporate finance.
There are many factors that complicate matters in such financing scheme. The minority owners of the project might desire to use the “off-balance sheet”. In this sheet, they reveal their partaking in the project as a venture and leave out the liability from financial statements by claiming it as an annotation related to the venture. One other factor that is concerned only with the developing countries is the war risk insurance or terrorism insurance. Such insurance does not come under the standard policies. But with such forces involved it will increasingly become difficult to complete the project on time. Also many a times a third party insurer might issue a performance bond to make sure that the project is completed on time by the contractor.
Thus, from the above talks it is quite clear that project financing is by far the most intricate of all the financing methods. And it needs certain requirements to be met before venturing into such a financing scheme. But it is the best suited scheme for huge projects where long term investments are expected with magnanimous infrastructure and large amounts of money at stake both for losses and for profits.
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