A project finance can be called as the complete analysis of the project’s life cycle. To determine whether the economic benefits of the projects are higher than its costs, a special technique of cost-benefit analysis is used. There can be various sources of Project Finance available for Start-ups and SMEs. But before financing a project its components and benefits must be thoroughly checked in detail.
Components of Project Finance:
The components make it easier to understand the proper definition of the Project Finance in India. These components are-
- Limited Recourse Financial Structure: When sponsors using equity or debts create specific economic entity called Special Purpose Vehicle (SPV) through structure financing of the Project Finance.
- Cash Flow Payments generated from the project finance initiative: The cash flow generated from the SPVs must be adequately sufficient to pay off the capital debts and interests.
- Providing finance for long-term public services, infrastructure and industrial projects: Project Finance are generally used in sectors related to infrastructure, oil extraction and power production.
Types of sponsors for Project Finance:
Every project sponsor has their own clear-cut motives and objectives behind participating in the project finance ventures. These motives depend upon the type of sponsorship. Such transactions usually occur when the following type of sponsors are involved in it-
- Financial Sponsors: With the objective of capital investing in deals of high profits, they play a specific part in the initiative of the Project Finance. These sponsors usually seek high substantial profits and returns on their investment as they have high risk propensity.
- Public Sponsors: It includes sponsors that have the objective to work for the social welfare of people like central, local or state government, municipalities, public companies or municipalized companies.
- Industrial Sponsors: They look at the initiative of the project which is related or linked to the core of the business in some ways or as the integrated upstream and downstream.
- Contractors: These are the ones that build, run or even develop plants. By providing subordinate debt or equities, they are interested to participate in the initiatives of the Project Finance.
Reasons for sponsors using Project Finance:
Any sponsor or the entity having funds to finance a project can choose one of the two alternatives to finance a specific project. These methods are-
- Project Finance: This type of financing is done off balance sheets and the initiative of the project finance is done by incorporating it into newly created economic firm. This means that new project and the existing firm of the sponsors are two separate legal entities. The creditors have no claim on the assets and cashflow of the existing firm, in case the projects are unsuccessful.
- Corporate Finance: In this type of financing the new initiatives are being financed on the corporate balance sheet. A sponsor uses all the cash flow and assets of the existing company to provide additional guarantees on the credit or funds given by lenders. If a project fails or turns out unsuccessful then, the firm’s remaining cash flow and assets can become a source for repayment of the funds to the lenders.
A sponsor mainly uses Project Finance in India for investing in a new initiative or project to gain more and more profits. And it also ensures that the existing company of the sponsor is secured from the creditors unlike in corporate finance where the assets and cashflow have to pledged as guarantee to the lenders for repayment in case project fails.