What is the Project Finance?

Probably, twenty years ago this term has not been common to hear it; However, with the passage of time, infrastructure works and large projects have been increasing and financing tools changing. It is within this framework that Project Finance is developed as a financing tool different from the traditional ones, which allows the promoters or “sponsors” to develop large-scale projects.

Although Project Finance has similar characteristics to other financing mechanisms, it differs from the others, mainly because it is a financing technique (typically long-term) based on the capacity of the project to be financed to generate positive cash flow. Cash flow refers to the inflows and outflows of money that a company or project has.

Since financing is given against the positive cash flow of the project, it is very important that these flows are predictable. For this, sophisticated financial models are used to “forecast” the future flow that the project will be able to generate.

However, depending on the future flow, the Project Finance may or may not incorporate certain elements that allow applying a measure against the sponsors in case the project is not finalized. This will depend on the particular risks of the project itself and the risk that the financiers want to assume. Examples of measures or remedies against sponsors are: the bonds to guarantee the construction of the project, or the trusts.

As I pointed out in the second paragraph, Project Finance shares several similarities with other financing modalities, but it also has other particular characteristics such as the use of a special purpose company for its development, it has a high leverage, it has a strong legal structure and is backed by all the assets linked to the project.

In line with this, that a project can be financed through Project Finance does not necessarily mean that it must be done through this mechanism. In my opinion, for a project to be financed through this technique, it must be: identifiable, profitable and long term; otherwise it would generate more expense for the company.

Finally, the risk in Project Finance is very important, since as it is based on future cash flow, there is a greater degree of uncertainty about the risks that could be generated. Consequently, the risk analysis is essential and should be carried out at an initial stage of the project, in order to determine the impact that these may generate.

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Raul Artola
Raúl Artola is a lawyer from the University of Lima, Master in Public Management and Postgraduate in Mining Project Management from the Pontifical Catholic University of Chile. He currently serves as Head of the Legal Area at Energy Group, a Peruvian-American business group dedicated to the exploration, exploitation, distribution and transportation of hydrocarbons.

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