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Project Finance


Project Finance — A Contemporary Alternative to Conventional Financing

Project Financing

Project finance refers to the private funding of an economically separable investment project with limited recourse or non-recourse alternatives. Recourse holds the debtor obligor liable for default payments, whereby creditor obligee recovers the debt to finance.

Recourse holds the debtor obligor liable for default payments, whereby creditor obligee recovers the debt to finance the project.

Non-recourse loans typically use the property as collateral to secure payment—seizing property if debtor defaults—without holding the debtor liable. [i]Project finance assumes a contract among privy parties to finance the project. Basic project finance features include:

These assurances mitigate liability by considering such contingencies.

Conventional Financing

Conversely, conventional financing employs lenders to service loans by generating cash flow from the “firm’s entire asset portfolio.” [ii]

Project Financing v. Conventional Financing

Project financing distinguishes from conventional financing in the following:
Unlike project finance, which solicits private funding independently by committing responsible “sponsors” under contract, conventional financing relies on a firm’s asset portfolio to recompense loans. Project financing assumes a contract with privy parties. The project commits independent sponsors under contract for outside funding. Additionally, unlike conventional financing, project financing pays cash flows directly to investors. [iii] In conventional financing, the sponsor reinvests cash flows. [iv]

However, the use of asset portfolios in conventional financing to repay loans assumes no need for a contract. Therefore, conventional financing assumes no collateral to secure loans because firms presumably need no extrinsic funding since the firm’s asset portfolio may suffice for loan reimbursement. Evidently, the asset portfolio provides a sufficient source of cash for repayment in conventional financing.

Since project financing assumes a contract, various interested parties presumably share financial risks. Not so with conventional financing, since the firm generally relies on its asset portfolio for financing. Furthermore, project financing, unlike conventional financing, assumes a finite life due to its contractual commitments because contracts expire as per the statute of limitations in each jurisdiction. Because conventional financing assumes no contracts, the firm’s project entity may perpetuate in perpetuity unless it otherwise specifies.

Project Financing & Conventional Financing—Distinguishing Features

The firm’s general credit distinguishes project financing from conventional (direct) financing. But project finance critically distinguishes from conventional financing as follows:

Project Financing

Other Distinguishing Features

Contractual arrangements with “unquestioned ability to generate cash flow,” for debt repayment support project financing because contracts entail specifications unambiguously stipulated and mutually exchanged among privy parties. The contracts also promise “reasonable return” to equity holders. Equity funds stem from special purpose vehicles, with banks, bondholders, and other institutions (commercial lenders) subsidizing debts.

In project financing, creditworthiness depends on the project’s anticipated profitability and indirect third party credit support. Therefore, fund availability for project financing depends on the sponsor’s ability to convince fund providers of a technically feasible and economically viable option. Not so with conventional financing because the firm ostensibly requires no contract, which perhaps assumes no outside financial support.

Distinguishing Features

Project Financing

Conventional Financing

Organization LLC/Partnership (though LLC legally preferred). Corporate.
Control & Monitoring Fund providers. Corporate directors monitor funds.
Debt structure Secure debt as per requisite specifications. Unsecured debt due to no contract, greater risks without certain terms specified.
Risk Allocation Distributes risk through contract arrangements;

Limited/no recourse.

Manages risks; full recourse; thus no risk-sharing.
Financial Structures Time-consuming because of contractual provisions to accommodate all privy party needs in preparing services/outside funding. Quick because the firm may easily duplicate common forms without the formality of securing specific commitments, legal arrangements, etc.
Free Cash Flow Managers with limited cash flow discretion as per contractual distribution specifications for equity investors. Managers maintain broad discretion as per company policies.
Agency Costs Reduced exposure. Equity investors’ greater exposure to agency costs of free cash flow.
Debt Capacity Extended to outside support. Limited to the firm’s entire asset portfolio.
Bankruptcy Less costly & expeditious with contract provisions guiding liability measures. Costly & time consuming with no formal specifications memorialized.


Project Financing Advantages

Project Financing may offer the following advantages to conventional financing:

However, project financing may not always lead to a lower after-tax risk-adjusted cost of capital. If so, project financing costs may not outweigh the aforementioned advantages enumerated. Therefore, project financing may present risk factors to lenders and investors, given the legal expense associated with many contracting parties over an extended time.

Those risk factors include:

The complexity of Project Financing

Project financing depends on a set of contracts negotiated by all parties privy to the project. If true, the dependence on “all” parties may require time, assuming schedule flexibility challenges. Likewise, cost arrangements may prove challenging for multiple external parties. Thus, these costs may offer greater challenges than conventional financing, where the firm need not rely on all parties, but simply consider its internal resources for payment. If so, project financing may create some ambivalence for lenders and/or investors, perhaps dubious of the risk that perhaps not all parties may commit. If so, lenders and/or investors may fear not receiving the returns promised, assuming they choose a project financing arrangement.

Indirect Credit Support

The cost of debt increases in project financing compared with conventional financing due to indirect credit support. In other words, the contracts entailed in a financing project typically assume many contingencies from contractual commitments, rather than a direct promise to repay. Consequently, lenders and/or investors may become concerned about possible contractual commitment failures, which might not provide an uninterrupted flow of debt service due to unforeseen events. Force majeure risks happen, and even if triggered from provisions, the liabilities associated with unfulfilled obligations may take many years of legal dispute/litigation, assuming courts rule in creditors’ favor. Furthermore, to compensate for this risk, lenders often take a 50-100 basis point cost in yield premiums. The added costs to compensate for the indirect credit support risks may dissuade lenders and/or investors even further from pursuing project financing, perhaps if conventional financing omits these costs, without contingency risk issues.

Higher Transaction Costs

Again, project financing assumes greater complexity compared to conventional financing. This higher complexity may assume additional higher transaction costs to reflect contingencies implied from legal expense in designing projects and/or project-related legal/tax issues. The requisite documentation in contracts for loans, project ownership, and legal services may entail much needless expense, perhaps further dissuading lenders/investors from project financing alternatives.


[i] Investopedia, Non-recourse Debt Definition, Investopedia, LLC, 2016,, p.1.
[ii] Finnerty, John D., Project Financing, Asset-Based Financial Engineering, John Wiley & Sons, Inc., 3rd Edition, 2013, p. 2.
[iii] See Finnerty John D., at 30-31.
[iv] See Id. at 30-31.


Finnerty, John D., Project Financing, Asset-Based Financial Engineering, John Wiley & Sons, Inc., 3rd Edition, 2013.
Ehrlich, Everett M., Public Works, Public Wealth, Center for Strategic & International Studies, 2005.
Khan, M.F.K., and R.J. Parra, Financing Large Projects: Using Project Finance Techniques and Practices, Pearson Education, Prentice-Hall, 2003.
Nakagava, D., Funding Transport Systems, Pergamon, 1998.
National Academies Press, Guidance for Communicating the Economic Impacts of Transportation Investments, 1999.
OECD Publishing, Transport Infrastructure Investment, 2008.
OECD, Infrastructure to 2030, July 2006.
Pollic, Gerald, International Project Analysis and Financing, University of Michigan Press, 1999.
Urban Land Institute, Infrastructure 2008: A Global Perspective, September 2008.

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