Project Financing
Introduction
The term “project finance” is applied slackly by academics, journalists and bankers to explain a variety of financing systems. Often kicked around in trade journals and industry meetings as a Modern funding method, project financing is in reality a century old financing scheme commenced even before the corporate finance started. On the other hand with the volatile growth in privately funded infrastructure projects in the emerging world, the practice is enjoying regenerated care.
Kinds of project financing
The techniques of Project financing can be traced back to at least 1299 A.D. During this period the English Crown funded the exploration and the evolution of the Devon silver mines by paying back the Florentine merchant bank and Frescobaldi from the output of the mines (Kensinger and Martin, 1993 p. 326). The Italian bankers in this case took a lease for one-year and also made up some mining concession, equal to the amount of silver they could mine in a year. In this illustration, the main feature of the project financing was the usage of the project’s output or assets to assure financing.
Another type of project finance was utilised to finance ships’ sailing and voyages till the 17th century. Capitalists would furnish financing for trading missions on a voyage-by-voyage basis. Once the ship returns the cargo and ships would be liquidated and the returns of the voyage divided between investors. Individual capitalists would then resolve as to whether investments in the sailing ship’s next voyage should be made or to use the capital for other purposes.
Definition of Project financing
A singular definition for project financing cannot be found. According to Wynant (1980) project financing is “a financing of a major independent capital investment that the sponsoring company has segregated from its assets and general purpose obligations.”
The World Bank (1994) defines project financing as the “use of non-recourse or limited-recourse financing.” Further the bank continues its definition and states that the funding of a project does not reoccur since lenders are repaid only from the cash flow brought forth by the project or, on completion of the event or on the complete failure of the project. The value of the project’s assets is used for repayment. Lenders also have fixed recourseto the assets of a parent company patronising a project.
The most important feature of project financing is the ‘art’ of lessening and allocating the chance among the several players, such as sponsors, service providers, purchasers and loaners (Traverso.1994, p.5).
Critical analysis of Project financing
Project financings are suited only for large-scale projects that involve a big deal of debt and equity capital. The capital demand of the project might run into billions of dollars. Infrastructure projects fit into this category. The World Bank study undertaken in 1993 detected that the mean dimension of project funded infrastructure projects in emerging countries was $440 million.
On the other hand, projects in their planning phases had a mean size of $710 million. Apart from this these dealings lean to be highly supplied with debt accounting for normally 65% – 80% of capital in comparatively common cases. Also the time period for project financings can simply reach 15 to 20 years.
Modern project financings regularly depend on recently founded legal entity, which is known as the project company and the main purpose of which is to execute the project of a finite life. Thus project financing cannot outlive its original purpose.
The project company becomes the borrower. As these newly constituted entities do not possess their personal credit or functioning histories, it is crucial for loaners to concentrate on the particular project’s cash flows. According to Chance (1991, p. 3) “the financing is not primarily dependent on the credit support of the sponsors or the value of the physical assets involved.”
Thus, it calls for a completely different credit valuation or investment determination procedure to find out the potential dangers and rewards of a project financing. In the former, loaners set a considerable level of trust on the operation of the project itself. Consequently, they will relate themselves intimately with the viability of the project and its understanding to the affect of potentially contrary factors (Chance. 1991, p.3).
In reality project financing can raise bigger amounts of long-term, foreign equity and debt capital for a project. It defends the project patrons’ balance sheet. According to Forrester (1995, p.54) “Through properly allocating risk, it allows a sponsor to undertake a project with more risk than the sponsor is willing to underwrite independently.”
Under project financing the contractor is liable for constructing the project based on the technical stipulations drafted in the contract with the project company. These main contractors will then sub-contract with home firms for elements of the construction. Contractors also possess interests in projects. For instance, Asea Brown Boveri produced a monetary fund, ABB Funding Partners, to buy interests in projects where ABB is a service provider. Contributors to the fund are a mix of institutional capitalists centred on the energy sphere, and the financing branches of big service providers (Edwards, 1995, p.110).
The project financings require preparing disclosure documents on a very extensive basis. In addition to this the capital market investors will most likely not presume construction risk. The trustees of the bond have greater role to play thus giving rise to more disparate investors. Also due to the proceeds being disbursed in a single lump sum payment this leads to negative costs (Simpson and Avery, 1995, pp.43-47).
Conclusion
A consciousness of the realities of project finance is crucial. There is a risk that some projects picked out for the sample may not be adequately advanced for sufficient documentation to be obtainable to carry out guarantee (Rodriguez, 2008).
Project financing has developed through the centuries into mainly a vehicle for gathering a syndicate of capitalists, loaners and other players to attempt infrastructure projects which is large enough for individual capitalists to insure.
The more current important instances of project finance structures assisting projects are the building of the Trans-Alaskan pipeline and geographic expedition and operation of the North Sea oil fields.
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