Project Finance and Corporate Finance are also referred to as Balance Sheet Financing. There are two financing models to fulfill the requirement of a business entity, where both rely on debt and equity as a source of funds.
What is Corporate Finance?
The objective of the Corporate Finance model is to ensure the optimal usage of the available capital and maximize the shareholders’ wealth. Corporate Finance is the financing model, to put all its projects/ business segments under one roof and consolidate the cash flows.
The Corporate Finance model shares the risks attached to the respective projects/segments and the rewards too are shared. It particularly helps the entities having various projects with a similar risk profile. The success or failure of these projects affects the corporate balance sheet directly.
In the event of a payment default to the lenders, company assets can be laid claim upon since they are held collateral. The security offered to the lenders is generally common and on all the assets and cash flows of the business entity.
Similarly, a company that might need to reorganize following a bankruptcy filing could use corporate finance to gain access to capital or reorganize debt. Corporate executives also use this type of financing to add value for shareholders by improving operations and ultimately generating greater profits.
What is Project Finance?
Project Financing is a long-term, zero, or limited recourse financing solution that is available to a borrower against the rights, assets, and interests related to the concerned project. As this scheme provides financial aid off the balance sheet, the credit of the Government contracting authority or the shareholders is not affected. Since Project Financing shifts part of the risk associated with the project to the lenders, this financial plan is one of the most preferred options for private sector companies.
With Project Financing, a company can arrange for a loan based on the cash flow generated at the end of a project while using the assets, rights, and interests of the concerned project as collateral. Be it a long-term infrastructure, public services, or industrial project, sourcing funds to implement and successfully run an undertaking is an integral part of the entire process.
The repayment of this loan can be done using the cash flow generated once the project is complete instead of the balance sheets of the sponsors. The lender is entitled to take control of the project, in case the borrower fails to comply with the terms of the loan.
Key Features of Project Financing
Below mentioned are the key features of Project Financing:
- Capital Intensive Financing Scheme: Project Financing is ideal for ventures requiring a huge amount of equity and debt, and is usually implemented in developing countries as it leads to the economic growth of the country. To ensure the project against these risks, the project also has to pay expensive premiums.
- Risk Allocation: Risks associated with the project are shifted towards the lender. Therefore, sponsors prefer to avail this financing scheme since it helps them mitigate some of the risks. On the other hand, lenders can receive a better credit margin with Project Financing.
- Multiple Participants Applicable: As Project Financing often concerns a large-scale project, it is possible to allocate numerous parties in the project to take care of its various aspects.
- Asset Ownership is Decided after Project: Once the project is completed, the project ownership goes to the concerned entity as determined by the terms of the loan.
- Zero or Limited Recourse Financing Solution: The financial services company can opt for limited recourse from the sponsors if it deduces that the project might not be able to generate enough cash flow to repay the loan after completion.
- Loan Repayment With Project Cash Flow: In Project Financing, the excess cash flow received by the project should be used to pay off the outstanding debt received by the borrower. As the debt is gradually paid off, this will reduce the risk exposure of financial services companies.
- Better Tax Treatment: The project /or the sponsors can receive the benefit of better tax treatment. Therefore, this structured financing solution is preferred by sponsors to receive funds for long-term projects.
- Sponsor Credit Has No Impact on Project: While this long-term financing plan maximizes the leverage of a project, it also ensures that the credit standings of the sponsor have no negative impact on the project
Project Financing is a long-term, non-recourse, or limited recourse financing scheme used to fund massive projects. The repayment is using the project cash flow obtained after the completion of the project. This scheme offers financial aid off-balance sheet, therefore, the credit of the shareholder and Government contracting authority does not get affected. In Project Financing, multiple participants are allowed to handle the project, the ownership of the project is entitled according to the terms of the loan only after the project is completed. This financial scheme offers a better credit margin to lenders while shifting some of the risk from the sponsors to the lenders.