Every new business project requires funding. Sometimes projects are small and sometimes they require huge investments.
Projects finance is a type of funding wherein the person who lends money is interested in revenue generation by particular project for covering both repayment of money and as security. Normally, project finance or Business loans are for large and complex installations which may include infrastructure, power plants, chemical processing plants, mining etc.
Normally, project finance covers projects relating to Greenfield, expansion of capacity for existing manufacturing units, construction and infrastructure projects. The nature is normally term loan as well as working capital loan.
These types of project loans are approved only when there is strong viability of project and also strong credit standing of borrowers.
Some of the areas where project loans or project finance are required are as under:
- Under Infrastructure sector:
- Construction of roads and PPP projects
- Projects relating to Power sector like solar energy, Wind energy, Hydro Power and Transmission Lines
- Oil & gas, other natural resources
- Construction of Ports and Airports
- Construction of Telecommunications
- Expansion and repairs of Railways
- Smart Cities &Urban Infrastructure
- Under Non-infrastructure sector:
- Sectors of Manufacturing like Cement, steel, auto components, engineering, mining, textiles, Pulp & papers, chemical & pharmaceuticals…
- Sectors of Services like Hospitality & Tourism, health industry and Educational Institutions etc
What lenders look for while providing project funding?
- There should be Certainty of Revenue Stream
- All necessary approvals from the host government and any local authorities has been taken and that the government will not change its regulation of the project’s operation in such a way as to inhibit the project development and production plans, or the revenue stream.
- Various Financial Ratios and Financial Covenants. Some of the ratios in which lenders are interested are:
Debt-Equity (D/E) Ratio
Lenders will prefer a lower debt‑to‑equity ratio whereas Borrowers will prefer high debt equity ratio. This is because lower debt equity ratio provides the lender with comfort that there is a good “equity buffer “in the event that the project company gets into difficulties.
Loan Life Cover Ratio (LLCR)
It is the net present value of cash available for debt service up to the loan maturity, divided by the outstanding principal. It is expressed as a ratio of the number of times the cash flow (over the scheduled life of the loan) can pay outstanding debt balance.
Lenders will prefer a minimum LLCR so that the total revenue available to the project is adequate over the life of the loan to repay total amount of outstanding debt.
Debt Service Cover Ratio (DSCR)
It measures the amount of cash flow available which can sufficiently meet amount payable as interest and principal payments on debt.
Rate of Return (ROR)
It is the ratio of amount of money invested and how much gain or loss made on such money invested on an annual basis. It can be return earned on both debt and equity. Internal rate of return (IRR) is the discount rate that results in a net present value (NPV) of zero of revenues over the project period, which shows the annualized effective compounded rate of return
Return on equity (ROE),
It is the return expected after servicing of debt, providing equity investors with a picture of their return over the period of the project. Private investors normally expects a high rate of return when they provide equity funding for a project.
- There should be control mechanisms of the company such as what activities borrower company can do without lender approval and whether lender has power to step in if project is not performing.
- Lender would want some warranties that Borrower Company will not change project plan, project contracts, capital expenditure program or debt program without lender consent. Similarly, it should provide warranties relating to the legal, financial, and commercial status of the Project Company, and performance and operations of the works.