Are you thinking about starting a new energy company? or perhaps wondering about the process? Here's a brief on how can possibly go about it, including important terms and concepts in debt financing.
The early process of project finance beings with an entrepreneur or parent company realizing an economic opportunity. Through a back of the envelop calculation, rough estimates are made to evaluate if the project is profitable and financeable. The entrepreneur or the company determines the institutional and financial structure for the project. If they determine to proceed through project finance then an LLC is established to protect from the liabilities. The case is then presented to the utility buyer to obtain a financeable PPA through the help of a competent lawyer. The PPA is brought to the investment banker to assist secure the capital required to finance the project. The investment banker helps to obtain debt financing by matching investors to the project. The investment banker will also assist in creating a Pro Forma and other wide range of financial services required for the project finance. Through the debt financing process, because of the non-recourse nature of the project finance, the parties are interested in reducing uncertainty by appropriate risk allocation and mitigation. Some of the important stages in the project finance are provide below:
Offering memorandum: Offering memorandum is the first step in securing an investment. It contains a detailed overview of the project and participants. It includes the capital required, EPC contract, and other entities involved in the project along with their creditworthiness. Offering memo helps to solicit bids from the lenders to obtain the capital.
Commitment Letter: After you have a lead bank, you then arrange to put together the letter of intent or the commitment letter. Commitment letter is a negotiating document that includes the
terms and conditions that need to be met to get a loan. This is subject to the due diligence to the parties.
Credit Agreement: Credit Agreement is the second most important document in project finance after the PPA. It includes the terms and conditions of the loan, including how the loan is dispersed, interest rate and other important factors of the loan. Credit Agreement takes place after the borrower fulfills the obligations in the commitment letter.
Construction Contract: Construction contract is the biggest part of the project finance. The construction contract can either be turnkey, or EPC model. The three most important factors during construction are Price, Performance and Schedule. It is crucial for the plant to be build at specified cost, with specified performance levels before the COD. It is important to select a creditworthy construction contract, who have the credit to support obligations of the contract or have parent guarantee. The contract price should offer sufficient risk premium for the contractor to build the project as specified on the contract. The construction ends on substantial completion where the company takes the ownership of the project.
Security Documents: It is the project collateral that secures the loan and provides guarantees to pay back the funds. The lender is concerned with ensuring that they have sufficient authority to oversee or in need step in and take over the project in event of default. The contract could also include performance bonds and collateral warranties to protect from the losses in termination of the project.
Representation: It is the statement made by the contracting party stating that the fact provided is correct on the date made. Every time there is a reissuance of the contract, it is important to re-represent to know that nothing has changed. This process helps the parties to provides incentive not to deviate from the previously agreed contract.
Legal Opinions: Legal opinions are formal statements from the lawyers based on their legal knowledge and review of the facts that the information provided is true. This provides a backing of the representation. There legal opinions can be classified into 3 types - “would, could and should” types. Legal opinions is one of most valued documents in project finance since it provides reassurance to the lenders.
Covenants: Covenants are agreements or promises the company agrees to perform specified tasks in the future. The covenants would be either affirmative (agree to perform) or negative (withhold from certain action). Violating a covenant can lead to default under which the lender has the rights to undertake corrective measures.
Event of a Default: Any breach of rep, or covenants, bankruptcy, breach of credit support can lead to default. The contract includes remedies for default which provides steps to fix the breach through liquidated damages, termination of the contract, payment of direct or other measures. The final step is the foreclosure where the assets of the company is put up for sale to recoup the loan.
Although project finance offers significant challenge in terms of coordination, allocating risks and reducing uncertainty, the success can be rewarding. As the project building is completed and starts to generate predicted cash flows, the company can assign a developmental fee that the lender would be willing to finance as cost of the project.
