Project Financing From Commercial Sources – Part 2


Friday, November 10, 2017 4:18PM/Brickstone Partners 

We continue our article on funding sources below. Read the Part 1 of our article HERE

Performance bonds:
With any major project come the inherent risk factors associated with accidents on site, additional construction cost, completion delays and future cash flow. It is vital that bankers or sponsors reduce these risks or share them out with others through the correct guarantees, insurance and bonds. Several types of bond are available to ensure completion or performance under a construction contract and these can be used to provide some extra assurance to the project lender. The most common bonds are:

·         Performance bonds;

Tender bonds;

Advance bonds;

Retention bonds; and

Maintenance bonds. 

Owner/sponsor guarantees:
The owner of a project is the most obvious guarantor of a project financing transaction. However, subsidiaries established to run a project are often undercapitalized and have no established track record, leading to poor credit rating. Project lenders will therefore require guarantee from a creditworthy source, often involving the parent company. In most cases, this type of debt guarantee will appear as a liability on the consolidated balance sheet of the owner or sponsor. However, there are other forms of direct and indirect undertaking which, if structure correctly, could be treated by sponsor as off-balance-sheet liabilities. 

Sponsor may or may not be interested in owning a facility which is needed to provide it with a product or service. Figure 1 illustrates the process which will result in the sponsor owing the completed facility. Figure 2 illustrate the mechanism that the sponsor must establish if it does not wish to own the completed project but is prepared to act as a guarantor. The arrangement illustrated in figure 1&2 are both direct guarantees    

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Third party direct guarantees:
One objective of project financing is to ensure that no single part carries the financial burden or risk with the project. This can be achieved by combining different types of guarantee or undertaking from various parties in the form of bankable credit. Guarantees enable sponsors to transfer the financial risk of a project to a third party. This mechanism allows off-balance-sheet financing to take place, without which some project would not be possible. 

Third party guarantors must benefit from the transaction in other to make their involvement worthwhile. Any guarantor is thus, to some extent, a project sponsor. The advantage of third party guarantees is that the owner or sponsors (non-guarantor) are able to keep their liabilities off balances sheet. It is possible to categorize third party guarantors into the following group:

·         Suppliers;



Contractors; and

Government agencies 

The loan/lease obligations of the project company are guaranteed by a third party who does not wish to own or control the project company. Based on this guarantee, the project company is able to enter into a loan or lease agreement with the lender or leasing company. The relationships involve are illustrated in figure 3.  

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Third party indirect guarantees:
Third party indirect guarantees can take the form of “take or pay contract” or “throughput contracts”, and can be used to ensure a steady flow of fund once a project has been completed. These may include a supplier setting a fixed price for raw material over a predefined period, or the user of the project’s output agreeing to take a set quantity of goods at a fixed price. These types of arrangement are often sufficient to assure lenders of the project’s viability. A trustee (usually a bank) should act as an intermediary and, by controlling the flow of money, provide additional assurance to the lender. 

Take-or-pay contracts:
A take-or-pay contract is an administer organizing transactions amongst companies and their suppliers. With this sort of agreement, the company either takes the item from the supplier or pays the supplier a punishment. Figure 4 represents an ordinary take-or-pay contract.  

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Throughput contracts:
A throughput contract is usually an agreement between the owners of a transportation or processing facility and the potential users of that facility,(e.g. an oil pipeline), whereby the users agree periodically to pay a set amount in return for the processing or transportation of a product. The users should provide an agreed minimum quantity for each period and have to pay even if the contracted quantity is not provided. Throughput contract signed prior to construction can act as guarantees to future income and thus help to raise the funds required to finance the project. 

Figure 5 illustrates an arrangement for a typical throughput agreement. This agreement has been used to secure a loan which will be used to build a processing plant. A construction contract is formed between the processing company and the contractor. In this example, there are two sponsors who have throughput contracts with the processing company. The processing company enters into a loan and lease agreement whereby due under the throughput contract is assigned to a security trustee, who uses these to service the debt, any excess cash being paid to the processing company. The throughput contract signed by company A and company B must be disclosed in the companies’ consolidated balance sheet.  

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Funding policy:
As an example the British Airport Authority (BAA) recent funding policy has been to finance major British construction project by using the debt instrument in preference to equity. However, equity issues are favored when international project are being considered. To fund its operation, the company has to make use of both short-term and long-term finance. For example, long-term loans at a fixed rate are used to build new runways or terminal building, but fixed-rate, medium-term loans are often used for smaller projects. It is the responsibility of BBA’s treasurer to negotiate with the capital market and obtain a debt that is best for the company in general. This will involve assessing the cost of the debt in both financial and tax terms, and determine the associated risk and possible remedies. BAA’s corporate philosophy has been to give considerable autonomy to its subsidiaries. However, it does have a central treasure in order to:

·         Control and implement the group’s strategy;

Reduce overall finance cost;

Ensure that assets are fully utilized;

Ensure a good distribution of fund through the regional offices; and

Negotiate favorable borrowing terms with the banks. 

Source funding:
Over the years, BAA’s has selected the following financial instruments which it consider best suit the company’s requirement. The funding of project is not restricted to these sources, and new approaches are the considered so long as they are beneficial to the company.

1.       Short -term finance: are wellsprings of finance that are accessible for some organizations that experience regular income variances, or that generally require a little, fast advance to cover costs that will be reimbursed in anticipated income in less than a year. 

2.      Medium-Term finance: are wellsprings of finance accessible for the mid-term of between 3 – 5 years commonly used to finance an extension of a business or to buy expansive settled resources. It is generally the bigger measures of acquiring or the utilization of the assets that separates medium wellsprings of finance from here and now, in spite of the fact that some of the fleeting choices are accessible for the mid-term 

3.      Long term finance: is a type of financing that is accommodated a time of over a year. Long term financing administrations are given to those business substances that face a deficiency of capital. There are different long term wellsprings of finance. It is not the same as here and now financing which is typically used to give cash that must be paid back inside a year. The period might be shorter than one year also. 

4.      Unsecured loan: is a loan that is issued and bolstered just by the borrower’s reliability, as opposed to by insurance. An unsecured loan is one that is gotten without the utilization of property as insurance for the loan, and it is likewise called a mark loan or an individual loan. Borrowers by and large should have high FICO assessments to be endorsed for certain unsecured loans. 

Eurobonds: are bonds denominated in a currency different from the currency of the countries in which they are issued and sold. 

Learn how to package your project for investors. Download the Guide HERE 

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