The term "project financing" is widely used to define finance arrangements with source of repayments is restricted to the income flow generated by a particular development based on Shah (1987, 207)
Thakor (1987, 213) stated that in 1299 A.D. The English Crown started financing the exploration and development of silver mines by repaying a merchant bank with the resources from the mines. The bank held a one year contract and mining concession. The Bank entitled for as much as silver the company mined for a year. In this view, the characteristic of project financing clearly can be seen when the use of the resources to secure financing.
The term project financing has been evolving through ages into a group of investors, leaders and others to involve in large projects.
Hofman (1989, 181) stated that the definition of project finance is long term financing of infrastructure and industrial projects based upon the projected cash flows of the project rather than the balance sheets of the project sponsors
The use of project financing by individual investor may be a difficult liability resource since public are required to hit the market than individual. The use of project financing by company to (1) elevate capital, (2) diminish financial coverage, and (3) decrease capital costs. Hofman (1989, 181)
Wynant (1980, 171) claimed that project financing tends to bulky-scale project that requires great amount of debt and equity capital. Company uses the project financing mostly deal with infrastructure or energy project.
The use of project financing might be identified with the following key area
Capital Intensive
Project financing tend to be large scale projects as mentioned above. Sorge (1980) stated that his average size of project in developing countries was $440 million based on the study by World Bank in the late 1993.
Highly Leveraged
Wynant (1980, 166) claimed these transactions tend to be highly leveraged with debt accounting generally 65% to 80% of capital
Long Term
The tenor for the project might be reach between 15 to 20 years based on Wynant (1980, 167)
Independent entity with a finite life
Similar with the past financing, project financing often rely on a brand new established legal entity. The project company with the sole purpose of executing the project and has finite life based on Wynant (1980,167)
Non recourse
the project company is the borrower, since mostly the brand new formed entities do not have their own credit or operating histories, lenders normally focus on the specific project's cash flows. Additionally. It required entirely different credit evaluation or investment decision process to find out potential risks. Lenders normally will work with a specialist to determine project feasibility. Wynant (1980, 167)
Controlled dividend policy
to support highly leveraged project and significant debt of the borrowers with no credit history, the lenders has to bind a contractual agreement to have a regular audit with a report of generated cash flows. In the above silver mine example, for a year, the merchant bank gain access to the mines and entitled for the resources gain for a year, based on the article by International Project Finance Association
Allocated Risk
since the project may full of highly leveraged risk, Wynant (1980,168) stated that a proper allocation of risk might be needed to advance the projects to the next step.
Many Participants
Since the project financing tend to large project; Hofman (1989, 183) stated that there may be numbers of parties.
Costly
Hofman (1989, 184) stated that the greater needs for information, contractual agreement required significant costs.
The complexity of project financing may take a much longer period of time to structure, negotiate and document than a traditional financing. Because the risks assumed by lenders may be greater in a non-recourse project financing than in a more traditional financing, the cost of capital may be greater than with a traditional financing.
Hofman (1989, 230) stated that a syndicated loan is loan that is provided by a group of lenders and is structured, arranged, and administered by one or several commercial banks or investment banks known as arrangers.
In the example of silver mines, the merchant bank may generate large fund from a group of lenders. This group of lenders is called a syndicate who provide the fund.
As mentioned above the project financing tends to serve a large project run by large corporations, the loan most likely provided by commercial banks with a strong financial capital. The funds at these commercial banks may be generated from a group of investors. The potential risk at the large projects arranged and structured to generate a review of investment through a risk management analysis. The lenders and investors are initially concerned with financing immobile assets, and political area of a nation.
Conclusion
Project financing involves non-recourse financing of the development and construction of a particular project in which the lender looks principally to the revenues expected to be generated by the project for the repayment of its loan and to the assets of the project as collateral for its loan rather than to the general credit of the project sponsor. In the past years, the project financing has generated trends in the area of privatization and deregulation of industries. The infrastructure projects may be evaluated in some key areas such as capital, leverage, and risk. The lenders have to perform a full critical audit analysis especially in the aspect of project cash flow and data analysis to predict and remove high potential risk.
EXECUTIVE SUMMARY
Project Financing has been used in the past for financing high-risk, development-oriented ventures. Nowadays, project financing require a large amount of capital. The capital may be generated from a syndicated loan. The projects are funded on a non recourse basis. The initiative of project finance most likely is generated from Project Company, a single purpose entity with a finite life. The project company is linked to numbers of parties by contractual agreements that protect the details on how the project will be implemented. The risk will be generated from this process and proper risk allocation methods are required to manage a specific risk. In order to protect the right lenders and borrowers, a specific full audit analysis is necessary. This action may leverage the cost needed to perform evaluation and assessment. The form of project financing has generated trends in the area of privatization and deregulation of industries.
