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Project Management

Notes fund surplus exists. A fund deficit or surplus in projected financing must be balanced out
through discretionary financing by adjusting projections on long-term debt or equity. A
projected balance sheet becomes balanced when the projected increase in long-term debt
or equity equals the amount of fund deficit in initial financing projections. A projected
balance sheet can also become balanced if a business uses the projected fund surplus to
further increase asset investments or reduce initial financing projections.

9.10 Financing of a Project

Project finance is the long term financing of infrastructure and industrial projects based upon
the projected cash flows of the project rather than the balance sheets of the project sponsors.
Usually, a project financing structure involves a number of equity investors, known as sponsors,
as well as a syndicate of banks or other lending institutions that provide loans to the operation.
The loans are most commonly non-recourse loans, which are secured by the project assets and
paid entirely from project cash flow, rather than from the general assets or creditworthiness of
the project sponsors, a decision in part supported by financial modeling. The financing is typically
secured by all of the project assets, including the revenue-producing contracts. Project lenders
are given a lien on all of these assets, and are able to assume control of a project if the project
company has difficulties complying with the loan terms.
Generally, a special purpose entity is created for each project, thereby shielding other assets
owned by a project sponsor from the detrimental effects of a project failure. As a special purpose
entity, the project company has no assets other than the project. Capital contribution commitments
by the owners of the project company are sometimes necessary to ensure that the project is
financially sound, or to assure the lenders of the sponsors’ commitment. Project finance is often
more complicated than alternative financing methods. Traditionally, project financing has been
most commonly used in the extractive (mining), transportation, telecommunications and energy
industries. More recently, particularly in Europe, project financing principles have been applied
to other types of public infrastructure under Public Private Partnerships (PPP) or, in the UK, Private
Finance Initiative (PFI) transactions (e.g., school facilities) as well as sports and entertainment
venues.
Risk identification and allocation is a key component of project finance. A project may be subject
to a number of technical, environmental, economic and political risks, particularly in developing
countries and emerging markets. Financial institutions and project sponsors may conclude that
the risks inherent in project development and operation are unacceptable (unfinanceable). To
cope with these risks, project sponsors in these industries (such as power plants or railway lines)
are generally completed by a number of specialist companies operating in a contractual network
with each other that allocates risk in a way that allows financing to take place. “Several long-
term contracts such as construction, supply, off-take and concession agreements, along with a
variety of joint-ownership structures, are used to align incentives and deter opportunistic
behaviour by any party involved in the project.” The various patterns of implementation are
sometimes referred to as “project delivery methods.” The financing of these projects must also
be distributed among multiple parties, so as to distribute the risk associated with the project
while simultaneously ensuring profits for each party involved.

A riskier or more expensive project may require limited recourse financing secured by
a surety from sponsors. A complex project finance structure may incorporate corporate
finance, securitization, options (derivatives), insurance provisions or other types of collateral
enhancement to mitigate unallocated risk.

Project finance shares many characteristics with maritime finance and aircraft finance; however,
the latter two are more specialized fields within the area of asset finance.

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