Project Finance vs Corporate Finance

Project finance involves the creation of a legally independent project company financed with nonrecourse debt for the purpose of investing in a capital asset, usually with a single purpose and a limited life .

• What is non recourse debt Non recourse debt - It is a type of loan that is secured by collateral, which is usually property. If the borrower defaults, the issuer can seize the collateral, but cannot seek out the borrower for any further compensation, even if the collateral does not cover the full value of the defaulted amount. This is one instance where the borrower does not have personal liability for the loan. These types of projects are characterized by high capital expenditures, long loan periods and uncertain revenue streams. Analyzing them requires a sound knowledge of the underlying technical domain as well as financial modeling skills.

The above definition highlights the following features of Project Finance:

• First, Project Finance involves creating a legally independent project company to invest in the project; the assets and liabilities of the project company do not appear on the sponsors’ balance sheet. As a result, the project company does not have access to internally-generated cash flows of the sponsoring firm. Similarly, the sponsoring firm does not have access to the cash flows of the project company. In contrast, in Corporate Finance, the same investment is financed as part of the company’s existing balance sheet.

• Second, the purpose for Project Finance is to invest in a single purpose capital asset, usually a long-term illiquid asset. In contrast to a company which may be investing in many projects simultaneously, a project financed company invests only in the particular project for which it is created. The project company is dissolved once the project gets completed.


• Third, in Project Finance, the investment is financed with non-recourse debt. Since the project company is a standalone, legally independent company, the debt is structured without recourse to the sponsors. As a result, all the interest and loan repayments come from the cash flows generated from the project. This is in contrast to Corporate Finance where the lenders can rely on the cash flows and assets of the sponsor company apart from those of the project itself.

Project finance solves two financing problems:

1. It reduces the cost of agency conflicts inside project companies-The creation of a project company provides an opportunity to create a new, asset-specific governance system to address the conflicts between ownership and control. Because project companies are new and independent firms, project sponsors have the opportunity to create asset-specific governance systems to address these agency conflicts in ways that cannot be replicated under corporate finance .


2. It reduces the opportunity cost of underinvestment due to leverage and incremental distress costs in sponsoring firms.

How does Project Finance creates more value

The key to understanding why project finance creates value is to recognize that firms bear “deadweight costs” (DWC) when they invest in and finance new assets. Investment value = (Project value) - (Project DWC) - (Incremental Firm DWC)

In summary, this combination of structural features (extensive contracting, concentrated debt and equity ownership, separate legal incorporation, and high leverage) effectively controls managerial discretion at the project level. Relative to corporate governance systems, project governance systems are much more effective at eliminating wasteful expenditures, discouraging sub-optimal investment, and inducing coordinated, value increasing effort

The table below shows how Equity finance ,Project finance ,Corporate finance & Hybrid finance differ from each other .