What is Project Finance?
Project finance is an approach that involves structuring the debt related to the launching and maintenance of the effort in a manner that allows the project itself to generate enough revenue to pay off that debt within a reasonable period of time. This strategy is often used by businesses when desiring to launch some sort of new project that is not provided for in the current budget. By essentially making the project self-sustaining, there is no impact on the other resources of the business and no need to trim expenses elsewhere as a means of financing the off-budget effort.
The actual mechanics of project finance involve securing financial support from an investor or a group of investors. As part of the structuring of the approach, investors provide a steady flow of cash during the startup phase of the project. That financial support continues until the project reaches a point at which it begins to generate profits that not only cover ongoing project expenses, but also allows the project owner to begin repaying the investors. Payments to the investors may take place in lump sums or according to a schedule agreed upon by all parties concerned at the time the project finance strategy is implemented. In addition to repaying the principal, the project owner normally also provides some type of interest on the debt, allowing the investors to earn a return on their support.
Depending on the nature and size of the project, the project finance effort may require a long-term financing commitment. More intensive projects, such as the launch of a new business, may require that investors wait several years before the company builds a client base that is stable enough to provide some amount of return on the investment. In other situations, such as real estate deals in which property is renovated and sold at a profit, the investors may recoup their investment and realize a return in as little as six months.
One of the main advantages of project finance is that the project owner does not have to make use of his or her own resources to fund the project. Any other forms of income that are already in place can continue to be used for other expenses, with none of those funds being diverted to fund the new project. Assuming that the effort is financially sound, can be completed on time, and begins to generate profits within the time frame originally envisioned, investors are repaid in full and the project owner enjoys the benefit of receiving all future profits from the venture, for as long as the project continues.
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