how project finance works
as noted above the term project finance refers to the financing of long term industrial and or infrastructure projects most commonly for oil and gas companies and the power sector it is also used to finance certain economic bodies like special purpose vehicles spvs the funding required for these projects is based entirely on the projected cash flows some of the common sponsors of project finance include the following entities the project finance structure for a build operate and transfer bot project includes multiple key elements project finance for bot projects generally includes an spv the company s sole activity is carrying out the project by subcontracting most aspects through construction and operations contracts because there is no revenue stream during the construction phase of new build projects debt service only occurs during the operations phase for this reason parties take significant risks during the construction phase the sole revenue stream during this phase is generally under an offtake agreement or power purchase agreement because there is limited or no recourse to the project s sponsors company shareholders are typically liable up to the extent of their shareholdings the project remains off balance sheet for the sponsors and for the government not all infrastructure investments are funded with project finance many companies issue traditional debt or equity in order to undertake such projects off balance sheet projectsproject debt is typically held in a sufficient minority subsidiary and is not consolidated on the balance sheet of the respective shareholders this reduces the project s impact on the cost of the shareholders existing debt and debt capacity the shareholders are free to use their debt capacity for other investments to some extent the government may use project financing to keep project debt and liabilities off balance sheet so they take up less fiscal space fiscal space is the amount of money that the government may spend beyond what it is already investing in public services such as health welfare and education the theory is that strong economic growth will bring the government more money through extra tax revenue from more people working and paying more taxes allowing the government to increase spending on public services nonrecourse project financing