Project Finance

Tim Thompson
Corporate Restructuring

How is most corporate

investment organized?

In corporations

Debt is usually recourse to entire

organizations assets
Leverage is usually modest (obvious
exceptions)

What is project finance?

Refers to a wide range of financing structures. These

financing structures usually have one thing in common --the financing is not primarily dependent on the credit
support (credit quality) of the sponsors or the value of
the assets involved. Instead, debtholders (banks, public
lenders) place a substantial degree of reliance on the
performance (I.e., cash flows) of the project itself
Non-recourse (or at least limited resource) financing
Project finance is both a financial structure and a
corporate governance structure aimed at resolving
capital market imperfections and efficiently allocating
risk.

What types of projects?

Somewhat arbitrary, but

Single purpose capital investment

Stand alone entity
Finite and long life
Large in size

Project finance versus

conventional financing

Modigliani Miller still holds if its

assumptions are true

if there were no taxes or transactions

costs
no costs of financial distress
no agency conflicts
no information costs
THEN PROJECT FINANCE WOULD ADD NO
VALUE RELATIVE TO CONV. FIN.

Project finance is very

costly

Transactions costs very large

Contracts: very complex organizational
structure, not much flexibility
Long negotiations, long time to close
Fees (0.6% of deal size, similar to M&A)
DISADVANTAGE RELATIVE TO
CONVENTIONAL FINANCE

Costs of
distress/bankruptcy

Risk of default and allocation of this

risk very different than conventional
debt
Less risk contamination with other
parts of firm
Less co-insurance benefit
Rearranges states in which default
occurs
Trade-off, clearly

Agency costs

High leverage, dedicated cash flows,

very specific contractual terms for
repayment and contingencies

May limit opportunities for risk shifting

May limit cross subsidization incentives
May replace managerial incentives of a
public-sector project with a for-profit
venture, contracts used to enhance
incentives

May improve economics

MM theorem assumes the

investment is fixed

It may be that the investment itself is

improved by the structure

Walt Disney got huge tax and

governmental relief by setting up
EuroDisney as a project structure rather
than owning outright

Tax, govt. reg.s may be reduced

Outside guarantees

Project finance is usually high leverage

and non recourse to project sponsors

even with its possible benefits, this usually

leads to high risk debt, which is often illiquid,
costly and sometimes simply not available

Often a guarantee or credit support is

offered by

Governments/international agency
(IFC/World Bank)/Sponsors/etc.

Different contractual
relationships

Contracts needed:

Management/shareholder agency
relationship
Intercorporate agency relationship
Government/corporate agency relationship
Bondholder stockholder relationship

Definition of the organization

(corporation) is a nexus of these
contracts