When it comes to Project Finance, if you need the cash yesterday, please do not apply. Project Finance is precise and onerous and requires months of work and planning.
It is not the cheapest form of finance, but it does provide for ‘Greenfield’ solutions, based on projected cashflows. Moreover, Project Finance has some additional benefits for the company, which include:
Allows the company to ‘ring-fence’ the project and not affect its balance sheet or borrowing power.
Lending of funds is based on a stream of cashflows generated by proposed project assets. In a sense therefore, it is also considered to be a limited recourse funding, not exposing the company’s assets outside the project.
It provides a structure for ‘sharing’ risk and may involve several joint venture partners, particularly useful in cross border situations which could provide an opportunity for double or even triple dipping structures and tax advantages across jurisdictions.
A Project Finance approach allows for the careful management and control where a consortium is involved in a multi-discipline project. It provides for structure, discipline and project management processes which allow for the coordination of various participants.
The top five sectors (in order) preferred by financiers in this discipline are:
- Public Private Partnerships
- Oil and Gas
Other emerging sectors include Large Scale Manufacturing, Renewable Energy, and Leisure based sectors such as theme parks, resorts and casinos.
However, any sector can benefit from taking a similar approach to funding, and imposing the rigor of project finance internally.
Considering the inputs, risks and modeling sensitivities not only provides great insight for the management, but addresses concerns and provides comfort to investors and financiers in a way which goes beyond the usual best case scenario and worst case scenario approach most managers take.
In any type of Project Financing there are a number of risks (anything from 15 to 20), which need to be carefully considered. Part of the due diligence involved is to identify each risk, rank them in order of potential impact to the bottom line, and address where possible through mitigating strategies.
I emphasize “where possible” because there are some risks that you just simply accept as part of the course, in which case you merely identify and assess how the risk is allocated (who carries that risk). So what are some of the risks we look at?
- Supply Risk
- Reserve (Inputs)
- Force Majeure
If you have a project and do not consider each risk, then you run the risk of a credit committee rejecting the project (if lucky), and you will find an up hill battle in trying to obtain funding.
At worst though, if funding for the project is generated internally or through third party equity, an oversight of any of the risk factors mentioned potentially places the project and equity at an unacceptable level risk.
This type of financing takes time to negotiate, and for smaller sized projects, a contingent equity facility may be the best approach in order to save time.
The facility could allow a project to begin to take shape, fund bankable feasibility studies and provide a ‘bridging’ function, while the company negotiates longer-term project finance.
As project finance requires an equity component as well, the facility can be used for this, as well as creating a form of guarantee on behalf of the sponsors to provide an additional level of comfort to the lender, but without tying up huge sums of cash for the sponsor (developer).