Question

What is project finance? How does it differ from ordinary lending

Answer 1

Project finance is essentially a way to get a project done while protecting the other assets a company might have. As the project sponsor, your company, B Corp., that wants to build the project, would essentially set up a second company that will build the project. This smaller company is known as the project company; we’ll call it C Co. B Energy will own most or all of the equity in C and likely will run the day-to-day operations, too. Additional funding will come from independent lenders, who will give C loans. If the project goes wrong for any reason, C will go bankrupt, but, as the project sponsor, your company, B Energy, won’t be responsible for repaying any of C’s debts. Although a little complicated, this kind of arrangement is used all the time in B energy, infrastructure, and construction projects. In the case of energy projects, let’s break it down a little further.

As the project sponsor, the company looking to do the project, B Energy, could be a wind developer planning to build a new wind farm, an oil company starting development of a new resource, or a transmission company planning a new transmission corridor. An established company, this business has assets, liabilities and equity on its balance sheet. It would also have the in-house expertise to evaluate projects in the field and the connections to get them done. Even so, the equity holders in companies like B Energy Corp. want to limit their risk in case the project doesn’t work out.

In the public sector, this is like revenue bonds. The only source of prepayment is the project itself.

Safer bonds are general obligation bonds. ALL assets are of the company or government entity pledged as security for repayment.

Conclusion:
Ordinary lending allows some fluctuations in usage of funds to the borrower, while project financing is for a specific purpose and heavily monitored for use of funds and for generation of promised/projected revenue to pay back loan.