Concept of project finance

Concept

Project finance is the long-term financing of a specific project (such as a hydropower plant, road or pipeline) in which the lenders and investors look mainly at the cash flow and assets of the project itself, not at the balance sheet of the sponsors, for repayment of the debt and return on equity. A separate legal entity (special purpose vehicle, SPV) is usually formed for the project.

Main characteristics

• Separate project entity (SPV) with its own assets, contracts and accounts.
• Non-recourse or limited-recourse debt: repayment is from the project revenue.
• High leverage: commonly 70 to 80% debt.
• Risk allocation by contracts: construction (EPC), supply, offtake/PPA, operation and insurance contracts share the risk among those who can best manage it.
• Long tenor, often 10 to 20 years or more.
• Detailed feasibility and financial model with debt service coverage ratio (DSCR) checks.

Example

A private hydropower company builds a 30 MW plant. It forms an SPV, signs a PPA with the Nepal Electricity Authority, gets 70% of the cost as bank loans and 30% as sponsors' equity. The PPA revenue pays the loan instalments.

Why it is used

It allows big infrastructure to be built without putting the full risk on the sponsors or the government, and attracts private and foreign capital.