Table of Content

Chapter 1:- Conceptual Overview

Chapter 2:- Research Methodology
Chapter 3:- Theoretical Background
Chapter 4:- Case Study Introduction of Company profile
Chapter 5:- Data Analysis
Chapter 6:- Findings
Bibliography
Annexure

CHAPTER - 1

Chapter 1:- Conceptual Overview

INTRODUCTION OF THE PROJECT FINANCING

Project financing has become one of the core activities of banks in the recent years. With the
growth in the economy and the revival in the industrial sector coupled with the increasing
role of private players in the field of infrastructure, more and more banks are entering into the
project finance area. This examination is specially designed, in collaboration with the
Institute for Financial Management and Research (IFMR), Chennai, to familiarize candidates
with basic issues arising in financing projects, as well as risk analysis and risk mitigation
methodologies with a specific emphasis on structured financing.
The financing of long-term infrastructure and industrial projects based upon a complex
financial structure where project debt and equity are scope of the project financing.
Arranging short-term financing, controlling cash, managing accounts receivable, inventory
management are function including in project financing of finance management. A thorough
understanding and application of all these aspects is necessary to be able to maintain the
optimum level of finance within the firm.

The requirement of the project financing is depending upon the nature of the business. The
business may be small are large, but the requirement depend on the operation of the business
it means the cycle of the business. If the operating cycle is longer the requirement of finance
would be longer of the business.
According to the requirement financing agencies, companies and banks provided finance to
the borrowers in the form of fund based and non-fund based.
Managing cash inflow and out flows efficiently for the optimum use of capital and to release
the finance blocked in inventory and receivables constitutes the single largest problem have
in business. As such the solution on this problem is that to borrowing the finance from Banks,
financial institute etc. has increased tremendously in all aspects.

CHAPTER - 2

Chapter 2:- Research Methodology

Objective of Study

To understand the concept of Project financing, its various components, methods and
nature of project financing.

Another important objective is to analyze the various components of project

financing, which is specifically used in borrowing the finance for the small-scale
industry and large-scale industry. If focuses on the requirement and the procedures
applied by the banks for assessing and sanction the loan.

It also studies the various guidelines issued and recommended by various RBI
committees.

To apply these procedures at a practical level with the help of a case study.

To know the history and growth of company.

To know and understand the definition of the term Project financing in Goverment
Bank or NFBC.

To know and understand the meaning & definition of Projections and financial
statements.

To know the profit of Goverment Bank or NFBC.

To be acquainted with annual reports & contents.

To study the financial statement with the help of Project financing.

To analysis & interpret the financial statements and to preparation of Credit Monetary
Assessment (CMA)

To know & understanding the banking monetary system and how the bank sanction
the loan.

To find out the right projection of the company.

To understanding the project financing system and actualization in practical.

 Scope and Rationale of Study

Scope of the project:-

Company has given various guidelines, advice and projection for obtaining the
finance from the banks and other financial services. And developing of the company
keeping in the view economic of the country. I have under taken the study of fast
developing company with reference to its financial position. It is necessary to under
taken the impact of Goverment Bank or NFBC & various services provide to their
clients.

Methodology
Sources of Data Collection: Data Collection is key part of project work. There are two types of data collection, first is
primary source and second is secondary of data collection.

Primary Sources: The primary data includes company profile, financial statements, and case study has been
obtained from Goverment Bank or NFBC.

Secondary Sources:The secondary data relating to the procedures of assessment of project financing in smallscale industry (SSI), and large-scale industry, RBI guidelines etc. have been sourced from
reference books and websites.

Hypothesis:-

Project finance is the one of the biggest source of borrowing the debts.
6

Limitation of the study:-

The time, limitation is the most important problem to collect the various information.
Study is not relation to the current market position.
It required lot of time and more expensive.
Lack of technical knowledge of project financing, I could not understand some technical
terms of the project financing.

Limitation of Study

CHAPTER - 3

Chapter 3:- Theoretical Background

CONCEPTUAL FRAMEWORK

History of Project Financing:Limited recourse lending was used to finance maritime voyages in ancient Greece and Rome.
Its use in infrastructure projects dates to the development of the Panama Canal, and was
widespread in the US oil and gas industry during the early 20th century. However, project
finance for high-risk infrastructure schemes originated with the development of the North Sea
oil fields in the 1970s and 1980s. For such investments, newly created Special Purpose
Corporations (SPCs) were created for each project, with multiple owners and complex
schemes distributing insurance, loans, management, and project operations. Such projects
were previously accomplished through utility or government bond issuances, or other
traditional corporate finance structures.
Project financing in the developing world peaked around the time of the Asian financial
crisis, but the subsequent downturn in industrializing countries was offset by growth in the
OECD countries, causing worldwide project financing to peak around 2000. The need for
project financing remains high throughout the world as more countries require increasing
supplies of public utilities and infrastructure. In recent years, project finance schemes have
become increasingly common in the Middle East, some incorporating Islamic finance.
The new project finance structures emerged primarily in response to the opportunity
presented by long term power purchase contracts available from utilities and government
entities. These long term revenue streams were required by rules implementing PURPA, the
Public Utilities Regulatory Policies Act of 1978. Originally envisioned as an energy initiative
designed to encourage domestic renewable resources and conservation, the Act and the
industry it created lead to further deregulation of electric generation and, significantly,
international privatization following amendments to the Public Utilities Holding Company
Act in 1994. The structure has evolved and forms the basis for energy and other projects
throughout the world.

10

What is the Project financing?

Definition
Project financing involves non-recourse financing of the development and construction of a
particular project in which the lender looks principally to the revenues expected to be
generated by the project for the repayment of its loan and to the assets of the project as
collateral for its loan rather than to the general credit of the project sponsor.
"Project finance" is a method for obtaining commercial debt financing for the construction of
a facility. Lenders look at the credit-worthiness of the facility to ensure debt repayment rather
than at the assets of the developer/sponsor. Farm biogas projects have historically
experienced difficulty securing project financing because of their relatively small size and the
perceived risks associated with the technology. However, project financing may be available
to large projects in the future. In most project finance cases, lenders will provide project debt
for up to about 80% of the facility's installed cost and accept a debt repayment schedule over
8 to 15 years. Project finance transactions are costly and often an onerous process of
satisfying lenders' criteria.
Project finance involves the creation of a legally independent project company financed with
non-recourse debt (and equity from one or more sponsoring firms) for the purpose of
financing a single purpose capital asset, usually with a limited life.
This definition highlights the following features of Project Finance:
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 companys existing balance sheet.
The purpose for Project Finance is to invest in a single purpose capital asset, usually a longterm 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.
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 companies have very high leverage ratios compared to public companies. Esty
(2003b) points out that the average project company has a leverage ratio of 70% compared to
33.1% for similar sized

11

firms listed in the Composted database. The majority of project debt comes from bank loans.
Esty (2005) shows that bank loans comprise around 80% of project debt.
It is a method of financing very large capital intensive projects, with long gestation period,
where the lenders rely on the assets created for the project as security and the cash flow
generated by the project as source of funds for repaying their dues.

Principal Advantages and Objectives of the Project Financing

12

1. Non-recourse. The typical project financing involves a loan to enable the sponsor to
construct a project where the loan is completely "non-recourse" to the sponsor, i.e., the
sponsor has no obligation to make payments on the project loan if revenues generated by
the project are insufficient to cover the principal and interest payments on the loan. In
order to minimize the risks associated with a non-recourse loan, a lender typically will
require indirect credit supports in the form of guarantees, warranties and other covenants
from the sponsor, its affiliates and other third parties involved with the project.

2. Maximize Leverage. In a project financing, the sponsor typically seeks to finance the
costs of development and construction of the project on a highly leveraged basis.
Frequently, such costs are financed using 80 to 100 percent debt. High leverage in a nonrecourse project financing permits a sponsor to put less in funds at risk, permits a sponsor
to finance the project without diluting its equity investment in the project and, in certain
circumstances, also may permit reductions in the cost of capital by substituting lowercost, tax-deductible interest for higher-cost, taxable returns on equity.

3. Off-Balance-Sheet Treatment. Depending upon the structure of a project financing, the

project sponsor may not be required to report any of the project debt on its balance sheet
because such debt is non-recourse or of limited recourse to the sponsor. Off-balance-sheet
treatment can have the added practical benefit of helping the sponsor comply with
covenants and restrictions relating to borrowing funds contained in other indentures and
credit agreements to which the sponsor is a party.

4. Maximize Tax Benefits. Project financings should be structured to maximize tax benefits
and to assure that all available tax benefits are used by the sponsor or transferred, to the
extent permissible, to another party through a partnership, lease or other vehicle.

DISADVANTAGES.
Project financings are extremely complex.
It may take a much longer period of time to structure, negotiate and document a project
financing than a traditional financing, and the legal fees and related costs associated with a
project financing can be very high. Because the risks assumed by lenders may be greater in a
non-recourse project financing than in a more traditional financing, the cost of capital may be
greater than with a traditional financing.

PROJECT FINANCING PARTICIPANTS AND AGREEMENTS.

13

1.

Sponsor/Developer. The sponsor(s) or developer(s) of a project financing is the

party that organizes all of the other parties and typically controls, and makes an
equity investment in, the company or other entity that owns the project. If there is
more than one sponsor, the sponsors typically will form a corporation or enter into a
partnership or other arrangement pursuant to which the sponsors will form a "project
company" to own the project and establish their respective rights and
responsibilities regarding the project.

2.

Additional Equity Investors. In addition to the sponsor(s), there frequently are additional
equity investors in the project company. These additional investors may include one or
more of the other project participants.

3.

Construction Contractor. The construction contractor enters into a contract with the
project company for the design, engineering and construction of the project.

4.

Operator. The project operator enters into a long-term agreement with the project
company for the day-to-day operation and maintenance of the project.

5.

Feedstock Supplier. The feedstock supplier(s) enters into a long-term agreement with the
project company for the supply of feedstock (i.e., energy, raw materials or other
resources) to the project (e.g., for a power plant, the feedstock supplier will supply fuel;
for a paper mill, the feedstock supplier will supply wood pulp).

6.

Product Off taker. The product off taker(s) enters into a long-term agreement with the
project company for the purchase of all of the energy, goods or other product produced at
the project.

7.

Lender. The lender in a project financing is a financial institution or group of financial

institutions that provide a loan to the project company to develop and construct the
project and that take a security interest in all of the project assets.

14

FIRST STEP IN A PROJECT FINANCING: THE FEASIBILITY STUDY.

A. Generally. As one of the first steps in a project financing the sponsor or a technical
consultant hired by the sponsor will prepare a feasibility study showing the financial
viability of the project. Frequently, a prospective lender will hire its own independent
consultants to prepare an independent feasibility study before the lender will commit to
lend funds for the project.

B. Contents. The feasibility study should analyze every technical, financial and other aspect
of the project, including the time-frame for completion of the various phases of the
project development, and should clearly set forth all of the financial and other
assumptions upon which the conclusions of the study are based, Among the more
important items contained in a feasibility study are:
Description of project.
Description of sponsor(s).
Sponsors' Agreements.
Project site.
Governmental arrangements.
Source of funds.
Feedstock Agreements.
Off take Agreements.
Construction Contract.
Management of project.
Capital costs.
Working capital.
Equity sourcing.
Debt sourcing.
Financial projections.
Market study.
Assumptions.

15

WHICH FIRMS IS NEEDS THE PROJECT FINANCE?

These are the firms wants project finance is as following: -

A. Legal Firm. Sponsors of projects adopt many different legal firms for the ownership of
the project. The specific form adopted for any particular project will depend upon many
factors, including:
The amount of equity required for the project
The concern with management of the project
The availability of tax benefits associated with the project
The need to allocate tax benefits in a specific manner among the project company
investors.
The three basic firms for ownership of a project are:

1. Corporations. This is the simplest form for ownership of a project. A special purpose
corporation may be formed under the laws of the jurisdiction in which the project is
located, or it may be formed in some other jurisdiction and be qualified to do business
in the jurisdiction of the project.

2. General Partnerships. The sponsors may form a general partnership. In most

jurisdictions, a partnership is recognized as a separate legal entity and can own,
operate and enter into financing arrangements for a project in its own name. A
partnership is not a separate taxable entity, and although a partnership is required to
file tax returns for reporting purposes, items of income, gain, losses, deductions and
credits are allocated among the partners, which include their allocated share in
computing their own individual taxes. Consequently, a partnership frequently will be
used when the tax benefits associated with the project are significant. Because the
general partners of a partnership are severally liable for all of the debts and liabilities
of the partnership, a sponsor frequently will form a wholly owned, single-purpose
subsidiary to act as its general partner in a partnership.

3. Limited Partnerships. A limited partnership has similar characteristics to a general

partnership except that the limited partners have limited control over the business of
the partnership and are liable only for the debts and liabilities of the partnership to the
extent of their capital contributions in the partnership. A limited partnership may be
useful for a project financing when the sponsors do not have substantial capital and
16

the project requires large amounts of outside equity.

4. Limited Liability Companies. They are a cross between a corporation and a limited
partnership.

B. Project Company Agreements. Depending on the form of project company chosen for a
particular project financing, the sponsors and other equity investors will enter into a
stockholder agreement, general or limited partnership agreement or other agreement that
sets forth the terms under which they will develop, own and operate the project. At a
minimum, such an agreement should cover the following matters:
Ownership interests.
Capitalization and capital calls.
Allocation of profits and losses.
Distributions.
Accounting.
Governing body and voting.
Day-to-day management.
Budgets.
Transfer of ownership interests.
Admission of new participants.
Default.
Termination and dissolution.

PRINCIPAL AGREEMENTS IN A PROJECT FINANCING.

17

A. Construction Contract. Some of the more important terms of the

construction contract are:

1. Project Description. The construction contract should set forth a detailed

description of all of the work necessary to complete the project.

2. Price. Most project financing construction contracts are fixed-price

contracts although some projects may be built on a cost-plus basis. If the
contract is not fixed-price, additional debt or equity contributions may
be necessary to complete the project, and the project agreements should
clearly indicate the party or parties responsible for such contributions.

3. Payment. Payments typically are made on a "milestone" or "completed

work" basis, with a retain age. This payment procedure provides an
incentive for the contractor to keep on schedule and useful monitoring
points for the owner and the lender.

4. Completion Date. The construction completion date, together with any

time extensions resulting from an event of force majeure, must be
consistent with the parties' obligations under the other project
documents. If construction is not finished by the completion date, the
contractor typically is required to pay liquidated damages to cover debt
service for each day until the project is completed. If construction is
completed early, the contractor frequently is entitled to an early
completion bonus.

5. Performance Guarantees. The contractor typically will guarantee that the

project will be able to meet certain performance standards when
completed. Such standards must be set at levels to assure that the project
will generate sufficient revenues for debt service, operating costs and a
return on equity. Such guarantees are measured by performance tests
conducted by the contractor at the end of construction. If the project
does not meet the guaranteed levels of performance, the contractor
typically is required to make liquidated damages

payments to the sponsor. If project performance exceeds the guaranteed

18

minimum levels, the contractor may be entitled to bonus payments.

B. Feedstock Supply Agreements. The project company will enter into one or
more feedstock supply agreements for the supply of raw materials, energy or
other resources over the life of the project. Frequently, feedstock supply
agreements are structured on a "put-or-pay" basis, which means that the
supplier must either supply the feedstock or pay the project company the
difference in costs incurred in obtaining the feedstock from another source.
The price provisions of feedstock supply agreements must assure that the
cost of the feedstock is fixed within an acceptable range and consistent with
the financial projections of the project.

C. Product Off takes Agreements. In a project financing, the product off take
agreements represent the source of revenue for the project. Such agreements
must be structured in a manner to provide the project company with
sufficient revenue to pay its project debt obligations and all other costs of
operating, maintaining and owning the project. Frequently, off take
agreements are structured on a "take-or-pay" basis, which means that the off
taker is obligated to pay for product on a regular basis whether or not the off
taker actually takes the product unless the product is unavailable due to a
default by the project company. Like feedstock supply arrangements, off
take agreements frequently are on a fixed or scheduled price basis during the
term of the project debt financing.

D. Operations and Maintenance Agreement. The project company typically will

enter into a long-term agreement for the day-to-day operation and
maintenance of the project facilities with a company having the technical
and financial expertise to operate the project in accordance with the cost and
production specifications for the project. The operator may be an
independent company, or it may be one of the sponsors. The operator
typically will be paid a fixed compensation and may be entitled to bonus
payments for extraordinary project performance and be required to pay
liquidated damages for project performance below specified levels.

19

E. Management Agreement.

F. Loan and Security Agreement. The borrower in a project financing typically

is the project company formed by the sponsor(s) to own the project. The
loan agreement will set forth the basic terms of the loan and will contain
general provisions relating to maturity, interest rate and fees. The typical
project financing loan agreement also will contain provisions such as these:

1. Disbursement Controls. These frequently take the form of conditions

precedent to each drawdown, requiring the borrower to present invoices,
builders' certificates or other evidence as to the need for and use of the
funds.

2. Progress Reports. The lender may require periodic reports certified by

an independent consultant on the status of construction progress.

3. Covenants Not to Amend. The borrower will covenant not to amend or

waive any of its rights under the construction, feedstock, off take,
operations and maintenance, or other principal agreements without the
consent of the lender.

4. Completion Covenants. These require the borrower to complete the

project in accordance with project plans and specifications and prohibit
the borrower from materially altering the project plans without the
consent of the lender.

5. Dividend Restrictions. These covenants place restrictions on the

payment of dividends or other distributions by the borrower until debt
service obligations are satisfied.

6. Debt and Guarantee Restrictions. The borrower may be prohibited from

incurring additional debt or from guaranteeing other obligations.

7. Financial Covenants. Such covenants require the maintenance of

working capital and liquidity ratios, debt service coverage ratios, debt
service reserves and other financial ratios to protect the credit of the
20

borrower.

8. Subordination. Lenders typically require other participants in the project

to enter into a subordination agreement under which certain payments to
such participants from the borrower under project agreements are
restricted (either absolutely or partially) and made subordinate to the
payment of debt service.

9. Security. The project loan typically will be secured by multiple forms of

collateral, including:

a. Mortgage on the project facilities and real property.

b. Assignment of operating revenues.

c. Pledge of bank deposits.

d. Assignment of any letters of credit or performance or completion

bonds relating to the project under which borrower is the
beneficiary.

e. Liens on the borrower's personal property.

f. Assignment of insurance proceeds.

g. Assignment of all project agreements.

h. Pledge of stock in project company or assignment of partnership

interests.
I. Assignment of any patents, trademarks or other intellectual property
owned by the borrower.

G. Site Lease Agreement. The project company typically enters into a long21

term lease for the life of the project relating to the real property on which
the project is to be located. Rental payments may be set in advance at a
fixed rate or may be tied to project performance.

Diagram of a Typical Project-Financed Deal

22

WHAT ARE THE TYPICAL CHARACTERISTICS OF PROJECTS FINANCING?

Some of the typical characteristics are: 1. Large capital costs
23

2. Long gestation periods

3. Assets are not easily transferable
4. Services provided are not tradable
5. Revenues only in local currency
6. Borrowing may be in foreign currency
7. Tariffs are politically sensitive
8. Social aspects involved
9. Vulnerable to regulatory policies
10. Limited recourse financing needed
What are the features of limited recourse/ non-recourse Project financing?
Some of the features are following:* Financing through Special Purpose Vehicles (SPV)
* Sponsor support obligation for SPV
* Use of Trust and Retention
Arrangement to capture the cash Flow
* Govt. guarantee may be available
Project Financing discipline includes understanding the rationale for project financing, how
to prepare the financial plan, assess the risks, design the financing mix, and raise the funds. In
addition, one must understand the cogent analyses of why some project financing plans have
succeeded while others have failed. A knowledge-base is required regarding the design of
contractual arrangements to support project financing; issues for the host government
legislative provisions, public/private infrastructure partnerships, public/private financing
structures; credit requirements of lenders, and how to determine the project's borrowing
capacity; how to prepare cash flow projections and use them to measure expected rates of
return; tax and accounting considerations; and analytical techniques to validate the project's
feasibility
Project finance is finance for a particular project, such as a mine, toll road, railway, pipeline,
power station, ship, hospital or prison, which is repaid from the cash-flow of that project.
Project finance is different from traditional forms of finance because the financier principally
looks to the assets and revenue of the project in order to secure and service the loan. In
contrast to an ordinary borrowing situation, in a project financing the financier usually has
little or no recourse to the non-project assets of the borrower or the sponsors of the project. In
this situation, the credit risk associated with the borrower is not as important as in an ordinary
loan transaction; what is most important is the identification, analysis, allocation and
management of every risk associated with the project.
The purpose of this paper is to explain, in a brief and general way, the manner in which
financiers in a project finance transaction approach risks. Such risk minimization lies at the
heart of project finance.
In a no recourse or limited recourse project financing, the risks for a financier are great. Since
the loan can only be repaid when the project is operational, if a major part of the project fails,
the financiers are likely to lose a substantial amount of money. The assets that remain are
usually highly specialized and possibly in a remote location. If saleable, they may have little
value outside the project. Therefore, it is not surprising that financiers, and their advisers, go
24

to substantial efforts to ensure that the risks associated with the project are reduced or
eliminated as far as possible. It is also not surprising that because of the risks involved, the
cost of such finance is generally higher and it is more time consuming for such finance to be
provided.
Risk minimization process
Financiers are concerned with minimizing the dangers of any events which could have a
negative impact on the financial performance of the project, in particular, events which could
result in: (1) the project not being completed on time, on budget, or at all; (2) the project not
operating at its full capacity; (3) the project failing to generate sufficient revenue to service
the debt; or (4) the project prematurely coming to an end.
The minimization of such risks involves a three-step process. The first step requires the
identification and analysis of all the risks that may bear upon the project. The second step is
the allocation of those risks among the parties. The last step involves the creation of
mechanisms to manage the risks.
If a risk to the financiers cannot be minimized, the financiers will need to build it into the
interest rate margin for the loan.
STEP 1 - Risk identification and analysis
The project sponsors will usually prepare a feasibility study, e.g. as to the construction and
operation of a mine or pipeline. The financiers will carefully review the study and may
engage independent expert consultants to supplement it. The matters of particular focus will
be whether the costs of the project have been properly assessed and whether the cash-flow
streams from the project are properly calculated. Some risks are analyzed using financial
models to determine the project's cash flow and hence the ability of the project to meet
repayment schedules. Different scenarios will be examined by adjusting economic variables
such as inflation, interest rates, exchange rates and prices for the inputs and output of the
project. Various classes of risk that may be identified in a project financing will be discussed
below.
STEP 2
Risk allocation
Once the risks are identified and analyzed, they are allocated by the parties through
negotiation of the contractual framework. Ideally a risk should be allocated to the party who
is the most appropriate to bear it (i.e. who is in the best position to manage, control and insure
against it) and who has the financial capacity to bear it. It has been observed that financiers
attempt to allocate uncontrollable risks widely and to ensure that each party has an interest in
fixing such risks. Generally, commercial risks are sought to be allocated to the private sector
and political risks to the state sector.
STEP 3
Risk management
Risks must be also managed in order to minimize the possibility of the risk event occurring
and to minimize its consequences if it does occur. Financiers need to ensure that the greater
the risks that they bear, the more informed they are and the greater their control over the
project. Since they take security over the entire project and must be prepared to step in and
25

take it over if the borrower defaults. This requires the financiers to be involved in and
monitor the project closely. Imposing reporting obligations on the borrower and controls over
project accounts facilitates such risk management. Such measures may lead to tension
between the flexibility desired by borrower and risk management mechanisms required by the
financier.
There are many risks in finance and these risks are help to overcome on finance, these risk
types is as following:Of course, every project is different and it is not possible to compile an exhaustive list of
risks or to rank them in order of priority. What is a major risk for one project may be quite
minor for another. In a vacuum, one can just discuss the risks that are common to most
projects and possible avenues for minimizing them. However, it is helpful to categories the
risks according to the phases of the project within which they may arise: (1) the design and
construction phase; (2) the operation phase; or (3) either phase. It is useful to divide the
project in this way when looking at risks because the nature and the allocation of risks usually
change between the construction phase and the operation phase.
1.
Construction
phase
risk
Completion
risk
Completion risk allocation is a vital part of the risk allocation of any project. This phase
carries the greatest risk for the financier. Construction carries the danger that the project will
not be completed on time, on budget or at all because of technical, labour, and other
construction difficulties. Such delays or cost increases may delay loan repayments and cause
interest and debt to accumulate. They may also jeopardize contracts for the sale of the
project's output and supply contacts for raw materials.
Commonly employed mechanisms for minimizing completion risk before lending takes place
include: (a) obtaining completion guarantees requiring the sponsors to pay all debts and
liquidated damages if completion does not occur by the required date; (b) ensuring that
sponsors have a significant financial interest in the success of the project so that they remain
committed to it by insisting that sponsors inject equity into the project; (c) requiring the
project to be developed under fixed-price, fixed-time turnkey contracts by reputable and
financially sound contractors whose performance is secured by performance bonds or
guaranteed by third parties; and (d) obtaining independent experts' reports on the design and
construction of the project. Completion risk is managed during the loan period by methods
such as making pre-completion phase drawdown of further funds conditional on certificates
being issued by independent experts to confirm that the construction is progressing as
planned.
2. Operation phase risk - Resource / reserve risk
This is the risk that for a mining project, rail project, power station or toll road there are
inadequate inputs that can be processed or serviced to produce an adequate return. For
example, this is the risk that there are insufficient reserves for a mine, passengers for a
railway, fuel for a power station or vehicles for a toll road.
Such resource risks are usually minimized by: (a) experts' reports as to the existence of the
inputs (e.g. detailed reservoir and engineering reports which classify and quantify the
reserves for a mining project) or estimates of public users of the project based on surveys and
other empirical evidence (e.g. the number of passengers who will use a railway); (b) requiring
long term supply contracts for inputs to be entered into as protection against shortages or
26

price fluctuations (e.g. fuel supply agreements for a power station); (c) obtaining guarantees
that there will be a minimum level of inputs (e.g. from a government that a certain number of
vehicles will use a toll road); and (d) "take or pay" off-take contacts which require the
purchaser to make minimum payments even if the product cannot be delivered.
Operating risk
These are general risks that may affect the cash flow of the project by increasing the
operating costs or affecting the project's capacity to continue to generate the quantity and
quality of the planned output over the life of the project. Operating risks include, for example,
the level of experience and resources of the operator, inefficiencies in operations or shortages
in the supply of skilled labour. The usual way for minimizing operating risks before lending
takes place is to require the project to be operated by a reputable and financially sound
operator whose performance is secured by performance bonds. Operating risks are managed
during the loan period by requiring the provision of detailed reports on the operations of the
project and by controlling cash-flows by requiring the proceeds of the sale of product to be
paid into a tightly regulated proceeds account to ensure that funds are used for approved
operating costs only.

METHODS OF THE PROJECT FINANCING:There are three Methods in Project Financing.

1. Cost Share financing or Low interest loan financing
2. Debts Financing
3. Equity Financing
These three methods are very important in project financing, this explanation is as following:1 Cost Share Financing or Low Interest Loans
There are few outright grant programs remaining for anaerobic digestion system funding. It
may be possible to receive a portion of the project funding from public agency sources. The
Environmental Quality Incentives Program (EQIP), administered by USDAs Natural
Resources Conservation Service (NRCS), promotes agricultural production and
environmental quality as compatible goals. EQIP was reauthorized and the funding amount
significantly expanded under the Farm Security and Rural Investment Act of 2002, which
requires that 60 3percent of EQIP funds be spent on animal operations. Anaerobic digesters
may qualify for cost share funding under NRCS programs. The owner should check with the
local or state NRCS offices to see if a digester project may qualify.
Another potential source of funding is a state energy program. At the time of publication, the
status of renewable energy low-interest loan or grant programs is in flux. AgSTAR has
identified approximately 30 states that offer financial assistance in the form of low-interest
loans, property tax exemptions, and grants. To learn more about these state programs and
other federal funding opportunities, review the Ag STAR publication, Funding On-Farm
Biogas Recovery Systems, EPA-430-F-04-002, and December 2003. Also Appendix B
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provides a list of NRCS and Department of Energy contacts that should be able to help the
owner contact the correct person in his state.
The advantage to receiving funding is the reduced project cost. The disadvantages are the
time and effort it takes to apply for and receive funding monies.
2 Debt Financing
Most agricultural biogas projects built in the last 15 years used debt financing, where the
owner borrowed from a bank or agricultural lender. The biggest advantage of debt financing
is the ability to use other peoples money without giving up ownership control. The biggest
disadvantage is the difficulty in obtaining funding for the project.
Debt financing usually provides the option of either a fixed rate loan or a floating rate loan.
Floating rate loans are usually tied to an accepted interest rate index like U.S. treasury bills.
Lenders Requirements
In deciding whether or not to loan money, lenders examine the expected financial
performance of a project and other underlying factors of project success. These factors
include contracts, project participants, equity stake, permits, technology, and sometimes,
market factors. A good borrower should have most, if not all, of the following:
Signed interconnection agreement with local electric utility company
Fixed-price agreement for construction
Equity commitment
Environmental permits
Any local permits/approval
However, most lenders look at the assets of an owner or developer, rather than the cash flow
of a digester project. If a farm has good credit, adequate assets, and the ability to repay
borrowed money, lenders will generally provide debt financing for up to 80 percent of a
facilitys installed cost.
Lenders generally expect the owner to put up an equity commitment of about 20 installed
using his/her own money and agree to an 8 to 15 year repayment schedule. An equity
commitment demonstrates the owners financial stake in success, as well as implying that
owner will provide additional funding if problems arise. The expected debt-equity ratio is
usually a function of project risk.
Lenders may also place additional requirements on project developers or owners.
Requirements include maintaining a certain minimum debt coverage ratio and making regular
contributions to an equipment maintenance account, which will be used to fund major

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equipment

overhauls

when

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necessary.