Project Financing – Outlook

Project financing is the core of any entrepreneurship. Be it a new business start-up or an expansion/diversification of an existing business, project finance has been proved to be an integral part of project planning and execution.

INTRODUCTION

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 its sponsors. Usually, a project financing structure involves a number of equity investors, known as ‘sponsors’, a ‘syndicate’ of banks or other lending institutions that provide loans to the operation. They 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.

– Scott Hoffman, The Law & Business of International Project Finance

IMPORTANCE OF PROJECT FINANCE

1. Project finance helps in risk sharing with creditors/financial institutions and the risk factors generally are mitigated within the project itself.
2. Project finance is the best route for arranging capital for huge capital incentive projects and those which have a long gestation period.
3. Loans are paid off from project cashflows only, thus it does not affect other businesses/projects of the sponsor.
4. Project finance provides better opportunities to manage and reduce the tax burden by optimizing the capital structure.
5. The ownership of the project is decided upon completion of the project. The Special Purpose Vehicle overviews the proceedings of the project while monitoring the assets related to the project. Once the project is completed, the project ownership goes to the concerned entity as determined by the terms of the loan.

NATURE OF PROJECTS

• New projects or Greenfield projects – The Greenfield project means that work which is not following prior work. In infrastructure, the projects on the unused lands where there is no need to remodel or demolish an existing structure are called Green Field Projects. E.g. New production facility.
• Brownfield Projects – The brownfield projects are the ones in which the sponsor invests in an existing facility to start its operations. In other words, a brownfield investment is the lease or purchase of a pre-existing facility which is used mostly to acquire facilities in foreign countries. E.g. Tata Motors’ acquisition of Jaguar Land Rover in the UK.
• Forward or backward Integration – Backward integration is the acquisition/ incorporation of controlled subsidiaries aimed at the creation or production of certain inputs that could be utilized in the production. Forward integration is business activities that are expanded to include control of the direct distribution or supply of a company’s products. E.g., Expansion did by Alok Industries to include Spinning facilities to retail outlets.
• Diversification – To enter in the business vertical which is not related to current business and has a different risk- rewards model. E.g., Launch of Jio Network by Oil and refinery major Reliance Industries
• Drafting Debt Restructuring Scheme – to optimize the loan and interest repayment with various methods including by taking control of distressed assets.

STAGES OF PROJECTS FINANCE

PRE- FINANCING STAGE

A. Identifying the project

Project identification is the initial process of evaluating the ideas and businesses which may have a budding market demand and potential profit growth. It can be the new business start-up idea that came to aid the current business models, products, or services. Regular businesses also scout for new opportunities in order to deploy surplus funds or to deploy assets to generate an income stream.

A project report helps in shaping the idea in monetary terms. It generally includes the following details –

1. Information about the industry including local and global economic status, present production and demand patterns;
2. Description of various production processes involved;
3. Location of plant/place of business with its advantages and justification;
4. Cost of production and cost of the project including the costs of human resources, technology, and other components of your project;
5. Details of capital structure and broad pattern of financing mix including repayment strategies for any borrowed funds;
6. Gestation period and profitability after commissioning of the project including the break-even point;
7. Impact of environmental and other factors affecting the project;
8. The competitive advantage in terms of advancement of technology or innovation of products or innovative service model;
9. Market survey to identify the markets in which your products will be sold, including industry trends, tariffs, and other barriers to entry. Also, the demand in terms of geography, rural/urban concentration, consumer preferences and affluence of customer base, competition level, etc.

B. Determine the feasibility of the project

A promising idea can be turned into a successful project only if it is feasible on various factors. It is the next and most important step to determine the feasibility of launching the project. This step involves drafting a carefully detailed plan of action that reflects various aspects of the technical, commercial, economic, and social feasibility of the project. A detailed project report (DPR) is prepared which includes the feasibility report too.

A feasibility report is a paper that examines a proposed solution and evaluates whether it is possible, given certain constraints.

Financial Institutions generally conduct a feasibility study on the following aspects of the project –

1. Technical feasibility – Review of infrastructure facilities, obtaining technical know-how, government policies, and sustainability
2. Economic feasibility –Review of demand forecasts for the market potential to absorb the product
3. Commercial feasibility – Review of terms of procuring the machinery and raw material that they are purely commercial in nature and does not, in any way, tend to benefit the promotors
4. Financial feasibility – Review of projected statements viz, balance sheet, sources, and uses of funds, projected cash flow statement to ensure that the total financial requirements cover the cost of fixed assets, working capital, initial losses, and contingencies. Also, it reviews the project’s debt service capacity and the proposed repayment schedule.
5. Managerial assessment – Probably the most crucial assessment as part of the feasibility study is the assessment of competence and reliability of management personnel. Managerial skills are assessed based on professional qualification, abilities, past records (including social & criminal), integrity, and honesty.

Risk management is one of the key steps that should be focused on before the project financing venture begins. Before investing, the lender has every right to check if the project has enough available resources to avoid any future risks.

FINANCING STAGE

In this stage, the sponsor needs to negotiate with the financial institutions, private equity investors, etc. to arrange the finance in terms of the equity or a loan or a combination of both. Borrower and lender negotiate the amount and terms as per the Project Report submitted by the borrower and come to the optimal ratio.

Capital incentive loans from commercial banks require a mortgage of the tangible assets and may require a personal guarantee from the promotors. Banks may be involved in vendor selection and negotiation processes. Capital margin to be brought in by the promotors is also an important term for such loans failing which will result in loan rejection.

Required documentation and verification is completed at this stage and the agreed-upon funds are brought in the project by the bankers and investors. This fund is used to carrying out the operations related to the project.

POST FINANCING STAGE

Once the capital is raised as per optimum capital structure, it is important to comply with the terms and conditions put down by the Financial Institutions/other investors.

Project monitoring is required at regular intervals to ensure timely completion and implementation of project assets. A project manager looks after the project’s designs and approvals, negotiations, and contracts with various creditors and plant commissioning and construction and trial production.

It also includes adherence to the loan repayment schedule and keeping track of project cash flows to optimize the use it. On completion of the project, the closure procedures are required in order to comply with relevant laws. Compliance with these terms of financing is crucial to continuing the project as per schedule.

USE OF PROFESSIONAL HELP IN PROJECT FINANCING

There are many finance professionals who will help during the full life of projects from initiation of projects to appraisal to commissioning to compliances.

A Chartered Accountant (CA) with a deep understanding of financial statements can help in the following ways –

1. Preparation of financial models, projected revenues, and cash flows.
2. Using a strong foundation in commerce and economics, helping in high-quality industry research and analysis as part of feasibility studies.
3. Help in preparation of Detailed Project Report (DPR).
4. Help in project evaluation and creating optimum capital structures.
5. Liaison with bankers, financial institutions, and private investors to reach at negotiations most beneficial to the projects.
6. Help in various compliances and submission of documents required in pre-financing and post-financing stages.

Project Financing is a very important aspect of modern business profiles. These decisions are generally irreversible in nature. The impact on the long-term profitability and competitive status of the sponsor. Hence, it has to be a well-thought step to choose project finance over corporate finance.