Project finance is the financing (funding) of long-term infrastructure, industrial projects, and public services using a non-recourse or limited recourse financial structure. The debt and equity used to finance the project are paid back from the cash flow generated by the project.
Understanding Project Finance
The project finance structure for a build, operate and transfer (BOT) project includes multiple key elements.
Project finance for BOT projects generally includes a special purpose vehicle (SPV). The company’s sole activity is carrying out the project by subcontracting most aspects through construction and operations contracts. Because there is no revenue stream during the construction phase of new-build projects, debt service only occurs during the operations phase.
Project debt is typically held in a sufficient minority subsidiary not consolidated on the balance sheet of the respective shareholders. This reduces the project’s impact on the cost of the shareholders’ existing debt and debt capacity. The shareholders are free to use their debt capacity for other investments.
- Project finance is the funding (financing) of long-term infrastructure, industrial projects, and public services using a non-recourse or limited recourse financial structure.
- A debtor with a non-recourse loan cannot be pursued for any additional payment beyond the seizure of the asset.
- Project debt is typically held in a sufficient minority subsidiary not consolidated on the balance sheet of the respective shareholders (i.e., it is an off-balance sheet item.)
When defaulting on a loan, recourse financing gives lenders full claim to shareholders’ assets or cash flow. In contrast, project financing provides the project company as a limited-liability SPV. The lenders’ recourse is thus limited primarily or entirely to the project’s assets, including completion and performance guarantees and bonds, in case the project company defaults.
Applicable law may restrict the extent to which shareholder liability may be limited. For example, liability for personal injury or death is typically not subject to elimination. Non-recourse debt is characterized by high capital expenditures, long loan periods and uncertain revenue streams. Underwriting these loans requires financial modeling skills and a sound knowledge of the underlying technical domain.
Recourse Versus Non-Recourse Loans
If two people are looking to purchase large assets, such as a home, and one receives a recourse loan and the other a non-recourse loan, the actions the financial institution can take against each borrower are different.