Key steps in financing a project

Most projects require some form of debt financing. In fact, a common feature (see Common features of project finance transactions) of project finance is that there is a significant level of debt (capital-intensive) and there is also a high expected return. The debt element of the funding for a project is typically referred to as “project finance”.

While no two project finance transactions are ever the same, there are certain key steps that are fundamental to securing financing for a project. It is useful to note that publicly procured projects are likely to have more steps than privately initiated projects. Those key steps for both publicly procured and privately initiated projects are explained in this guidance note.

See Key steps in financing a project.

Conducting due diligence and understanding “bankability”

Due diligence is an important part of any commercial finance transaction, but it is absolutely critical in project finance transactions because projects are inherently risky (see Identifying and analysing project risks and risk allocation — part 1).

Many projects share certain key areas of focus for the due diligence process, including feasibility, legal and political matters, environmental and social matters, insurance requirements and tax and accounting issues. This guidance note provides a summary of those areas and guidance on the type of information that the lenders will require. Importantly, this guidance note explains the concept of “bankability” in the context of a project finance transaction. “Bankability” determines whether or not lenders are prepared to provide financing for a particular project.

See Conducting due diligence and understanding “bankability”.

Source of funding in project finance

A project may be financed from several sources. The structure of any particular transaction will largely depend on the source of finance. This guidance note provides an overview of selected common sources of funding, including:

• • loans from commercial banks (such as in the form of syndicated loans);
• • finance provided by large institutional investors, such as superannuation funds and pension funds;
• • capital markets financing (bonds); and
• • assistance provided by export credit agencies.

This guidance note also considers the issue that Australia’s major trading banks often struggle to provide the long-tenor debt required to finance large projects on terms that are competitive with their overseas counterparts, and how the gap in the market for longer-tenor debt can be filled.

See Source of funding in project finance.

The use of project accounts in project finance

In a typical project finance transaction (see Introduction to project finance), the lenders (see Key finance parties and their roles) rely heavily on the revenues generated by the project for repayment of the loan (see Common features of project finance transactions).

As a result, project finance lenders will impose strict restrictions on how the project company (see Key project parties and their roles) uses its cash. This guidance note explains how the lenders commonly impose these restrictions in project finance transactions. Importantly, this guidance note explains how a system of bank accounts is established and the funds to be deposited into each account and that may be withdrawn from each account are detailed in the loan agreement. Common accounts that may be required in a project as covered by this guidance note include:

• • revenue account (also sometimes characterised as an operating account or proceeds account);
• • construction account;
• • insurance proceeds or compensation proceeds account;
• • debt service reserve account;
• • maintenance reserve account;
• • ramp-up account;
• • lock-up account; and
• • distributions account.

See The use of project accounts in project finance.

Financial model

Before embarking on a potential project, the proposed sponsor (see Key project parties and their roles) must prepare a “feasibility study” (see Conducting due diligence and understanding “bankability”) to assess the project's viability. If the sponsor decides that the project is viable, it will often then use the feasibility study to explain the project to potential lenders (see Key finance parties and their roles) and any equity investors.

A feasibility study analyses the key elements of a proposed project, and an important part of the feasibility study is the “financial model”. This guidance note explains what the financial model is, what it is used for and how it is checked by the lenders. It also explains the concept of the “base case” financial model, and what is a “model audit”.

See Financial model.

Project insurance — role, scope and issues

A key element of the solution to managing many project risks (see Identifying and analysing project risks and risk allocation — part 1) is to transfer that risk to insurers by way of one or more insurance policies. As such, ensuring that a comprehensive, adequate and robust insurance package is in place during all phases of a project (see Key steps in financing a project) is of critical importance to financiers (see Key finance parties and their roles).

Project finance lenders usually require an expert insurance adviser to report on the types of insurance that are appropriate for the project as well as levels of cover, excesses and exclusions. The lenders will want to be sure that risks associated with the project are covered by insurance as much as possible.

Among other things, this guidance note explains the types of insurance in project finance and considers matters relating to uninsurable events, key insurance covenants commonly included in the finance documents and the role of an insurance specialist in a project finance transaction.

See Project insurance — role, scope and issues.