Project finance is a long-term method of financing large infrastructure and industrial projects based on the projected cash flow of the finished project rather than the investors' own finances. Project finance structures usually involve a number of equity investors as well as a syndicate of banks who will provide loans to the project.
Key parties to a project financing
Private sector partner/owner: Usually a corporation or a limited partnership created for the sole purpose of the particular project. This party is at the centre of all contracts, borrowings and the construction and operation of the project.
Project sponsor: The person who takes on the active role in managing the project. The project sponsor owns Projectco and will receive profit, either as a result of the ownership of Projectco or via management contracts, if the project succeeds. The project sponsor often has to cover certain liabilities or risks of the project by providing guarantees or by entering into management or service agreements.
Lenders: Commercial banks, investment banks or other institutional investors who provide the debt portion of the project financing. The sheer scale of a typical project financing means that most lending cannot be undertaken by a single lender. Instead, group of lenders form a syndicate.
Agent: one of the lenders will be appointed as the agent and will act on behalf of the other lenders to administer the loan.
Account bank: a single lender will hold the accounts through which all the cash generated by the project will pass.
Equity investors: lenders or project sponsors who do not expect to have an active role in the project. In the case of lenders, they will have a shareholding in addition to lending by way of debt, as a way of receiving an enhanced return if the project is successful. In most cases any investment by way of shares is coupled with an agreement to allow the equity investor to sell its shares to the project sponsor if the equity investor wishes to exit the project. Similarly, the project sponsor may have the option to repurchase the shares.
Suppliers, contractors and customers: these include the suppliers of materials for the project, the contractors responsible for designing and building the project and the customers of the project.
Construction company: the construction contractor is one of the key project parties during the construction phase of the project. Typically, a construction contractor's remit will be based on one of two models:
- Turnkey model: where the construction company designs, engineers, procures and constructs the project output, assuming all responsibility for timely completion; or
- EPC model: where the construction contractor engineers, procures and constructs the project output.
Consortia of contractors may be involved in larger projects. As far as liability is concerned those contractors can be either severally or jointly and severally liable. Several liability means that each contractor is only liable for its own contribution to the project, while under joint and several liability any contractor can be pursued for the whole of the obligation and it will then be the responsibility of the consortium to sort out the extent of each contractor's obligations. Lenders prefer the joint and several liability, since the risk of failure of performance is then the total responsibility of each member of the consortium.
Multilateral credit agencies: Multilateral agencies are able to ensure the bankability of a project by providing commercial banks with a degree of protection against political risks, such as the failure of a government to make agreed payments or provide the necessary regulatory approvals.
Host governments/awarding authorities: the government of the country where the project is based is likely to be involved in issuing consents and permits both at the start and throughout the life of a project. The awarding authority is the contracting local authority which enters into the project agreement with Projectco.
Purchasers: in infrastructure projects, Projectco will normally contract in advance with a purchaser who will purchase the project's output on a long-term basis.
Insurers: insurers are vital to a project. If there is a catastrophe affecting the project, then the sponsors and the lenders will look to the insurers to cover the losses.