Of all the ways of providing money to infrastructure one technique, which has emerged as a benchmark for providing infrastructure financing and investing, is project finance. It is a technique whereby a group of investors becomes shareholders of a newly created special purpose vehicle (SPV) that is entitled to design, to build and to manage an infrastructure project.
The SPV together with its shareholders also called as project sponsors, approach a group of lenders, either a group of banks or a group of bondholders, in order to collect the additional amount of money that is necessary to build the infrastructure and manage it throughout its life.
Infrastructure finance or project finance can be seen as a network of contracts. Empirical evidence shows that normally a project finance transaction involves approximately 15 parties with 40 different contracts, adding a bit of complexity to the nature of the transaction. However, to simplify it, we can broadly divide the key contracts into two broad categories:
- Financial contracts: These are used to avail equity capital from sponsors and debt capital from lenders to the SPV.
- Industrial contracts: With these contracts, SPV, a 100 percent outsourced enterprise, receives assets to design, build and operate the project.
What is project finance?
Project finance is an industrial / infrastructural project financed off-balance sheet in an SPV within a network of contractual agreements with key counterparties (contractors, purchasers, suppliers, operator agents, etc). The term project finance is indicative because it is the financing of one specific project, namely infrastructure. It has the following characteristics:
• The borrower of funds is a project company set up on an ad hoc basis that is financially and legally independent from the sponsors (separate incorporation) which is called as SPV.
• All economic consequences generated by the initiative are attributed to the SPV that is designated to secure cash receipts and payments (lenders finance a venture, not an operating firm).
• The assets of the SPV are the only collateral available to lenders together with the cash flow from the initiative (no-recourse financing).
• Approval of the financing is a function of the project's ability to generate cash flow, to repay the debt contracted, and also pay capital invested at a rate consistent with the degree of risk inherent to the venture concerned.
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