Project Finance and Corporate Finance (also referred to as Balance Sheet Financing) are two financing models to fulfill the basic objective of meeting the requirement of fund of a business entity, where both rely on debt and equity as a source of funds. The thin line that separates them, are (i) the purpose behind availing these types of finances and (ii) the security offered. Overall financials of a company are managed through corporate finance, which begins with financial modeling, raising capital, and optimizing fund usage. On the contrary, project finance comes into the picture when a specific project needs funding and the project's assets and the project cashflows are offered as primary security apart from some additional collaterals. Despite the differences, corporate finance has often crept into the territory of Project Finance and has proven itself useful to finance certain projects. Theoretically, Corporate finance and Project Finance have very different meanings and purposes. Let’s try and understand these concepts better.
Corporate Finance is the financing model, where the management decides to put all its projects/ business segments etc under one umbrella and consolidate the cash flows. The objective of the Corporate Finance model is to ensure the optimal usage of the available capital and maximize the shareholders’ wealth. The Corporate Finance Model shares the risks attached to the respective projects/segments and the rewards too are shared. It particularly helps the entities having various projects with a similar risk profile. The success or failure of these projects affects the corporate balance sheet directly since the overall company assets are held collateral in Corporate Finance and can be laid claim upon, in the event of a payment default to the lenders. However, on the other hand in case one of the projects is under stress, the same can be met out of the positive cash flows of the other projects. Moreover, the model is very effective in case the entity plans for a large expansion, and equity is to flow from the cash flows of existing projects. The security offered to the lenders is generally common and on all the assets and cash flows of the business entity.
Independent projects of a company require the panache of Project Finance techniques, owing to the capital intensive, high risk, and time-taking (long gestation period) nature of such projects. In such cases, based upon the forecasted cash flow resulting from the project, capital through the Project Finance model is injected where mostly the project assets and cash flows are held securely. In such cases the project risks and rewards are ringfenced and they do not spill over to other projects/entities except to the extent to the investment in the said project. So, unlike Corporate Finance, Project Finance does not or minimally impact the corporate balance sheet because the right to claim on the assets in the event of failure to repay, extends to only the assets of the project ( and the additional security offered if any) and not of the parent company.
|
Attribute |
Corporate Finance |
Project Finance |
|
Stage |
Availed during the inception of a company and during any expansion |
Availed by established SPVs venturing into new projects |
|
The basis for credit evaluation |
Balance sheet, cash flow, and overall financial health of the company |
Project feasibility analysis, project asset value, and forecasted cashflow |
|
Risk |
Risk is common and consolidated. Any bad project may affect the over operations of the business entity |
Risk is restricted and ringfenced to the project and does not spill over to other businesses/projects. |
|
Returns |
Returns are Moderate as risk and returns are shared. |
Returns are high as the risk is high |
|
Collateral |
Overall assets/cash flows of the company |
Limited to only the project assets/cash flows |
|
Type of capital |
Permanent and exists throughout the life of the company |
Finite and limited to only the lifespan of the project |
|
Reinvestment |
Least restrictive covenants by the participants, mostly regulatory |
Reinvestment from revenue is not allowed and have to be adhered to as per the sanctioned conditions of the participants. |
|
Financial structure |
Common and Simple financial structures |
Tailormade financial structures that vary from case to case. |
|
Transaction costs |
Low cost due to risk-sharing and simple structure |
Higher costs due to tailor-made documentation requirements. |
|
Financial elasticity |
Higher financial flexibility due to less restrictive covenants |
Low Financial flexibility due to highly restrictive covenants. |
In view of the aforesaid discussions, it may be concluded that the Corporate Finance is a more suitable financing model for MSMEs, business with projects with the similar risk profile, entities having an organic expansion and where the management looks for operational and financial flexibility, whereas the Project Finance model is more suitable in case of high-risk projects, inorganic expansions, JV/PPP projects, projects/segments with the different risk profile.
