In the infrastructure sector, it’s important to have the flow of funds to complete the project with quality and under the guidance of experts. In the infrastructure sector, project finance is used for long-term and large projects. Let’s understand what project finance means in civil engineering and how it helps.
Project Finance in Civil Engineering
Project finance is commonly used for civil and large infrastructure projects managed by private companies to have the funds, although governments may also utilize this financing method. The project finance is a financial structure where the repayment of the returns on loans comes from the project revenue.
This approach attracted the private companies more as they can fund the large projects off-balance sheet, hence it would not impact the company’s credit and borrowing capacity. In the US, this approach of financing the infrastructure in civil engineering helps businesses to get large funding for projects, such as highways, telecommunications, and others.
The IIJA Act of 2021 drives this type of financing as it offers clean investment and meets the growing demand for infrastructure. The method also has some challenges that affect the companies and lead them to be cautious while using this funding method.
What is the structure of project financing in civil engineering?
This type of financing involves limited resources and a non-resource structure that will be beneficial for the projects as well as companies. The companies generally have a typical financial structure under the project finance to build, operate, and transfer the project.
If you are in the civil engineering profession or have company deals in the infrastructure industry, you should learn the basic elements of the project finance financial structure below:
- Special Purpose Vehicles: The SPVs are separate legal entities that raise the funds from loans or investors for the infrastructure construction and operation. The SPVs are the project company that will not have any business records, and its sole purpose is to fund the project. So, it’s created for a single project only and manages the cash flow.
- Contractor: The contractor sponsor will provide debt or equity for the project management and operation that is needed for the smooth functioning.
- Investors: Now, come the people who invest in the large infrastructure project for a big return from the project.
- Repayment: Under the construction phase, there is no revenue, so debt service will not happen until the project is completed.
- Resource: The funding under the project finance will be limited to non-resource sponsors for the project, so the shareholders are only liable till shareholding.
How does Project Finance benefit infrastructure funding?
Now that you understand the project finance methodology for the infrastructure financing, you should know the benefits and how it helps in the funding:
- Diverse investors: This approach allows the infrastructure project to have a diverse range of investors, such as industrial sponsors, development banks, credit agencies, etc., which makes the funds go to and help us deliver the quality infrastructure.
- Off-balance sheets: As the project finance allows companies to not include this funding in their balance sheet, it reduces the impact on the shareholders and companies. The off-balance sheet will help the investors to use their credit for other investments. The government can also use this method to reduce the fiscal deficit through infrastructure funding.
- Non-resource funding: With non-resource funding, the project financing will not require lenders’ claim on the shareholders’ assets.
- Increase the capital for large projects: Civil engineering projects, like metro, water, and highways, require large capital for the project operation and implementation. In such projects, the companies can raise high capital to raise funds for the billion-dollar projects based on the revenue in the future.
What are the risks and challenges involved in project finance?
The project finance does help the large project in the civil engineering in funding, however, it also involves some risks and challenges, such as:
- Operation Risk: With the project financing, if everything does not happen as per the project timeline or under the budget, it can affect the project. For instance, if inflation hits, it can affect the project’s estimated costs and alter the project’s profitability, which can affect the repayment.
- Repayment risk: The project finance relies on the cash flow of the repayment; hence, if the risk management is not done properly, the success of the project will be affected. IT can later increase the cost of expenditure and affect the repayment.
- Resource Allocation: To manage the cash flow and proper use of funds, it’s important that the resource allocation is deployed effectively, as this approach has many elements.
- Regulations: It’s important that you meet the regulations of the area where the project is happening to ensure your funds comply with all the laws and you do not later face any issues.
The project financing in civil engineering is ideal for the large infrastructure projects; however, it’s important you understand its elements before using it properly for your best advantage.
