What is project financing?

Project financing is a source of financing which mainly funds large-scale projects such as infrastructure, energy, transportation, manufacturing, and real estate. The debt used to finance the project is serviced solely from the cash flow generated from the project. This structure is attractive for many project owners as the financing is off-balance sheet, meaning the debt used to fund the project does not appear on the project owner's balance sheet and has no credit rating impact.

How is project financing structured?

A project is placed in a special purpose vehicle (SPV), which is a subsidiary of the project owner, such that only the assets, rights and cash flows from the project are placed and act as main collateral to the project debt. The project owner has no recourse or limited recourse under this structure and has full ownership of the project assets. Companies with a limited ability to raise capital can benefit from this source of financing so long as the project's viability and offtake agreement is strong. This is ideal for start-ups or small capitalization companies with large-scale projects. Normally, these companies would have to raise significant equity and restrictive debt which negatively impacts their ownership structure and subjected to debt covenants.

Off-balance sheet financing

Since the project is held in a SPV, the assets and liabilities are not reported in the project owner's financials. As a result, the project owner is not restricted with its debt capacity and debt costs and can use its debt capacity for other investments.

What are the risks associated with project financing?

Since the only collateral pledged are the assets and cash flows from the project, project owners need to plan and execute carefully to ensure the project's construction and operation are in accordance with the original plan as presented to the lender. This means all engineering, procurement, and construction (EPC) agreements are secured and offtake agreements are signed to ensure the project cash flows are highly predictable. As well, volume output estimates and key operational costs are properly supported with contingencies in place.