The treatment of project finance has primarily been for the infrastructure industry, but the processes and techniques used are also applicable to other off‐balance‐sheet financings of separate entities, joint ventures, and projects in other industries. Project finance has traditionally been treated from a financial engineering or from a contract finance perspective with applications in infrastructure projects in underdeveloped or developing countries lacking sufficient public and private resources to fund needed projects. Projects of such characteristics are the most challenging and once experience is obtained from such projects, it is easily transferable to projects in other industries and developed countries.

The globalization of business has intensified competition among project sponsors/developers, construction contractors, technology and equipment providers, and some funding sources. The result is coopetition in project development and financing that has increased the need for effective project finance solutions and better‐structured partnerships and joint ventures. In this environment, to win large project bids, sponsors need an overall competitive advantage. To create profitable investment projects, they need a disciplined, new business development approach to project finance.

Project finance is not a stand‐alone function based on contract finance or legal engineering as it is being treated in the current paradigm. It has been developed to advanced levels for the primary purpose of facilitating new project and business development activities with the nonrecourse aspect as an ancillary factor. It should be treated as part of new business development with its focus on striving to maintain or obtain competitive advantage. Hence, our approach to project finance is different than the one in the current literature and its novelty lies with the value created through addressing it from a broad, new business‐development perspective. Why? Because project finance is part of new business development and has to be viewed in that context and not as a stand‐alone discipline, and because its key objective is to get competitive advantage through new investments. Other reasons for and benefits of using this approach are explained later in the chapter.

Infrastructure projects are large investments by the public and/or private sectors that require major financial and human resource commitments to build physical assets and facilities needed for economic development and social functioning of a country. Infrastructure projects include power plants, pipelines, railroads, roads and bridges; ports, terminals, and airports; telecommunication networks, and water and sewage treatment plants. They also include social and healthcare facilities such as public housing, elder care facilities, prisons, hospitals, schools, and sports stadiums.

Due to their large and special financing requirements and challenges, infrastructure projects are usually placed in four categories:

1. Greenfield projects, where new facilities are built requiring larger capital investments than investments in existing project companies in operation
2. Brownfield projects, where investment is made to upgrade and refurbish existing facilities and equipment in order to increase productivity or extend their economic life
3. Stock or extraction projects, where natural resources are extracted and sold until depletion, such as coal and mineral mining, and gas and oil extraction
4. Flow‐type projects, where the project assets are used to generate income by selling their output or the use of their services. They include pipelines, toll roads and bridges, ports and airports, and so on

There are several definitions of project finance for different types of projects, all valid but each stressing some more than other parts of the discipline. However, we prefer the broader definition shown in the box. To understand what project finance is all about, the definition needs to be expanded to include the structuring of the project company, known as a special purpose company (SPC) or a special vehicle company (SPV); the characteristics of projects, what project finance involves, and the risks associated with a project. That is, it includes:

1. Structure of the company: Common SPC structures are corporations, joint ventures, partnerships, limited partnerships, and limited liability companies
2. Properties of projects: Infrastructure projects require large capital expenditure, entail massive negotiations and contracts, and require long operating periods
3. What project finance involves: It requires the creation of a legally separate, single purpose entity that is a shell company to build the project assets and capture revenues. Financing is of a limited/nonrecourse basis and it is based on cash flows and the assets owned by the SPC that is responsible for loan repayment
4. Risks associated with a project: Financing is provided to the SPC and not to the sponsors and this gives rise to risks usually mitigated through contracts, insurance, and credit enhancements. A common set of risks in project finance includes primarily political, demand, price, supply, currency, interest rate, and inflation risks
5. Project development complexities: Addressing them entails the undertakings of project screening and the feasibility study, project development, financial model development, and economic evaluation. It also requires project risk management, due diligence, a financing plan, financial structuring, creation of a project company business plan, and project implementation

A key objective of project finance is to minimize or avoid uncertainty. Unlike asset‐based finance, where the asset value determines financing, the adequacy of project cash flow is the foundation of funding. Since infrastructure projects have different types of assets and objectives, capital requirements, and risks; they get different benefits from project financing. However, infrastructure projects have a number of common characteristic due to the common project financing technique. Gatti (2012) names the common elements of project financings as: long economic life assets with low technological risk, provision of essential public services with inelastic demands, regulated monopolies or quasimonopolies with high barriers to entry, and stable and predictable operating cash flow.

The components of project finance are outlined in Section 1.6 and discussed in subsequent chapters, but the basic and common components across projects are the presence of a host government ceding agency, sponsor or developer equity, commercial bank loans, and institutional debt and equity investors. Usually, there is some subordinated debt from sponsors and other project participants, collateral security and revenue assignment, and enhancements provided by sponsors and unilateral and multilateral institutions. Also, there is a common set of project finance prerequisites such as a stable political and regulatory environment, reasonably adequate industry structure, sound project development and planning, thorough risk assessment and mitigation to allocate risks effectively, and contractual agreements to ensure project viability.

The historical origins of project finance and its evolution are traced in Section 1.1 and its advantages and disadvantages are briefly discussed in Section 1.2. The differences between project finance and corporate and structured finance are explained in Section 1.3. To get a sense of the importance of project finance, its size, and the industries it impacts, some of its characteristics are shown in Section 1.4.

Because project finance is part of business development, Section 1.5 provides the rationale for using a new business development approach to evaluate, structure, and fund project finance transactions aiming to create a competitive advantage for the company. The structure of the book and chapter contents is presented in Section 1.6 and how to maximize its benefits to the reader is explained in Section 1.7.

1.1 ORIGINS OF PROJECT FINANCE

The basic idea of project finance is not new, but it has evolved and refined through time and has now become a highly skilled discipline and an art. According to Miller (1991), elements of project finance present in Mesopotamian societies were expanded by ancient Greeks to foster maritime trade and to finance wars. Maritime loans were given to ship owners and merchants to buy goods for sale abroad with the understanding that if the ship returned, the loan would be repaid in full plus a return (often as high as 25% because of risks involved) out of the proceeds of goods sold abroad and out of the proceeds from the sale of cargo brought back. If the ship was lost at sea or did not return with cargo from abroad, in the first instance the loan was not repaid and in the second case was partially paid through proceeds of sales of cargo sold abroad.

The Athenians used project finance concepts to finance war in the following manner: They created an alliance of city‐states to fight the Persians using the Persian model that required members to pay an annual tribute. This enabled the Athenians to turn the alliance into an empire and their allies to get a share of the benefits. The Spartans used a different war financing method: They borrowed from a Persian king to fund building a fleet to fight the Athenians “in exchange for the right to levy tribute again on Ionia's Greeks” (Pritchard, 2015). The Romans enhanced the Athenian merchant model with legal agreements and created the fenus nauticus (sea loan), in which merchants would get to share the risk with the lender.

A more recent project finance experience is that of the British Crown financing of the Devon Silver mines in 1299, which repaid a Florentine merchant banker with rights to output from the mines in a one‐year concession (Kensinger and Martin, 1988). Beginning with the Age of Discovery, the English, French, Dutch, Spanish, and Portuguese lenders financed water irrigation, canal, road, and railroad construction projects in colonies primarily in India, Africa, South America, and the Middle East. The lenders were repaid from revenue proceeds from those projects or from taxation revenues. An example of such projects is the Suez Canal project in late nineteenth century by the French and the railroad network build by the British in India.

In the late nineteenth century, numerous oil and gas exploration and production ventures in the United States were financed with bank loans that were repaid from proceeds of sales of outputs from those projects. Also, in the early twentieth century, the US government financed the construction of the Panama Canal under a project funds transfer syndicated loan arrangement of eight banks led by J.P. Morgan. However, the North Sea project in the late 1970s resembled properties of modern project financing whereby British Petroleum raised a billion British pounds for that project's construction through a forward purchase agreement.

1.2 PROJECT FINANCE ADVANTAGES AND DISADVANTAGES

The reasons for using project finance are the several advantages it yields to different project stakeholders. The benefits of project finance vary by project type and participant and include the following:

1. Raises funding at a reasonable cost for projects not financeable by other methods
2. Minimizes equity contributions and thereby increases borrowing capacity for sponsors or developers through the project company
3. Avoids the risk‐contamination issue by diversifying political risk and mitigating other risks through allocation to parties best able to absorb and through insurance contracts
4. Higher leverage than on‐balance sheet finance translates into higher sponsor or developer return on investment
5. Well suited to finance large, capital‐intensive projects that have long construction periods and no revenue until start of operations
6. Project‐financed deals have the benefit and support of high‐quality counterparts, such as export credit agencies (ECAs), multilateral institutions, and global insurers
7. Lenders to projects and credit support parties provide incentives for and require careful project evaluation, risk assessment, and due diligence
8. Better managed and improved project company operations because of stringent lender requirements and controls of its cash flow
9. Provides incentives to lenders to cooperate in the project company's restructuring and reorganization and be less likely to foreclose
10. Increases public infrastructure investment than otherwise would be the case and enables governments to get value for their money; that is, greater project value and efficiency
11. Increases tax revenues for the host government and provides tax benefits to sponsors or developers
12. Reduces the cost burden for the host country government authority responsible for the project and affects transfer of technology, training, and know‐how to the host country

The other side of project finance is found in its limitations, and its disadvantages are lengthy and costly project development, risk assessment and mitigation, the due diligence process, and finance‐structuring challenges. Other disadvantages of project finance include:

1. Protracted contract negotiations and complex, lengthy, and costly project documentation, contractual agreement preparation, and contract negotiations
2. The large number of parties involved in the project, possible divergence of interests and objectives, and difficulties to reach consensus
3. Higher interest rates and fees than other forms of financing and high insurance costs to mitigate project risks and cover hedging contracts
4. Project development complexity and costs, combined with a lack of project financing competencies among project stakeholders, precludes the use of project finance in small projects
5. Lenders require a high degree of supervision over construction, and the SPC's management and operations have stringent reporting requirements
6. Project finance techniques used in one project cannot be easily replicated in other projects. This means that there is no process standardization and the result is higher costs to tailor processes and assessments to each project specifics

1.3 CORPORATE AND STRUCTURED VERSUS PROJECT FINANCE

In corporate finance, also known as direct finance, a company undertaking a new project finances it from loans and not from the project. To do that, the company proves to lenders that its balance sheet assets are of sufficient strength to use as collateral in case of default. Under this arrangement, the lender can foreclose and liquidate the borrower's assets to recover its investment. Unlike corporate finance, project finance is based on debt repayment from project company revenues and not on the sponsor or the developer's balance sheet assets.

Structured finance is a complex set of financial instruments available to large borrowers with needs that a simple loan cannot meet. It was created to help transfer risk though legal contracts, especially when those borrowers are involved in several projects. The crux of structured finance is bringing together mortgages, loans, bonds, and credit default swaps and then issuing tranches against those assets. The prioritization of claims makes the tranches safer than the average asset in the pool of assets, and structured finance is used when a number of separate tranches are required to meet project needs. This form of finance has grown in popularity since the mid‐eighties and examples of structured finance instruments are collateral bond obligations (CBOs), collateral debt obligations (CDOs), credit default swaps, and hybrid securities.

Development finance, asset based loans, and cash flow and covenant light loans are variants of project finance. Development finance for private or public–private partnership (PPP) projects is used in land acquisition and construction of housing, shopping malls, hotels, schools, hospitals, and sports facilities. It is also used to finance economic development projects such as ports, airports, roads, bridges, etc. On the other hand, asset‐based finance consists of revolving lines of credit or loans secured by the borrower's assets and are used for, among other projects, acquisitions, buyouts, and capital expenditures.

Cash flow and light covenant loans are often based on the credit of the acquired company with robust and stable cash flow and entities such as government agencies and regulated utilities. For clarity of presentation, our discussion of project finance is focused primarily on greenfield infrastructure projects although its principles apply to brownfield, extraction, and flow types of projects as well. While our discussion centers around international infrastructure projects, the principal components apply to domestic, private, or commercial new business development projects with a few elements that need adjustment to fit project specifics.

1.4 THE PROJECT FINANCE MARKET

According to McKinsey Global Institute (June 2016), the global infrastructure market is estimated to be $2.5 trillion invested in transportation, power, water, and telecommunications projects. The world needs, however, require average annual investments of $3.3 trillion to support currently expected economic growth with 60% of that to meet emerging market needs. The infrastructure market for 2006–2011 was $1.21 trillion and for the 2016–2030 period the investment need is projected to be $49.1 trillion.

To give a historical perspective, Table 1.4.1 shows the global finance market by amount and percent by region for the 2011 to 2013 period, which shows a decline in those years, but which has since been reversed.

In 2011, the shares of project finance by region show some annual variability, but for the 2006 to 2013 period those shares do not display any trends. The amount of global project finance by sector is shown in Table 1.4.2. Common, average timelines involved in infrastructure projects are shown in Table 1.4.3. It is instructive to observe how debt maturities overlap and appreciate the need for long concession agreements.

Bank loans are the major source of funding infrastructure projects and the distributions of funding during the 1994 to 2003 period and those of bond issues by region during the 2002 to 2012 period are shown respectively in Tables 1.4.4 and 1.4.5.

1.5 WHY A BUSINESS DEVELOPMENT APPROACH TO PROJECT FINANCE?

There are several ways to approach the discussion of the project finance area, each influenced by the interests and perspective of individual project participants. We mentioned earlier that there are various approaches to the subject, each focusing on line of interest issues and details. Each approach has merits and benefits, all of which are a subset of a necessarily broader treatment of effective project finance. Following are different ways and viewpoints used in the current paradigm to address the subject of project finance:

1. Infrastructure versus industrial project angle
2. Project sponsor or developer perspective
3. Customer viewpoint or host country government ceding authority perspective
4. Lender, multilateral agency, and institutional investor perspective
5. Special purpose company (project company) standpoint
6. Private finance initiative (PFI) versus PPP viewpoints
7. Relationship management, sales, and marketing view
8. Financial engineering perspective
9. Contract finance or legal engineering interpretation
10. Process and project management perspective

Projects cannot receive appropriate evaluations and structuring by project finance organizations (PFOs) and legal teams alone. The main reason for the new business development approach to project finance is that it helps to develop profitable projects and progress toward getting a competitive advantage for the sponsor company. This broader approach is required to address the diverse issues to develop, structure, and finance successfully project finance deals because project finance is an integral part and is used to facilitate new business development. Figure 1.5 shows why project finance has to be treated in that context and is an outline of how and when projects come on the radar of project finance teams, the organizations involved, and how they are processed down to the PFO level.

The great majority of requests for project proposals, investment opportunities, offers, and partnership initiatives never go directly to project finance organizations but first go through business development organizations coming through various venues from:

1. Sponsor company regional sales organizations
2. Different business units of the sponsor company
3. External agents such as government entities, business brokers, and investment bankers
4. Existing or potential new customers making inquiries and submitting request for proposals (RFPs), offers, and partnership initiatives

Figure 1.5 shows that a good part of project analytics and evaluations come from specialized expertise that provides support for the new business development approach. Once projects come to business development organizations, they go through screening and different fit assessments in conjunction with inputs from the corporate strategic planning, portfolio management, and CFO organizations. After projects pass that screening, they are passed on to the project manager, the PFO, and the project team. At that point, a more in‐depth screening takes place and project‐financing development begins in earnest, which involves several internal organizations and external advisors.

Although it addresses all key elements of every project finance treatment angle, our approach is focused on a new, integrated, business development, business planning, and project‐financing method characterized by the following properties:

1. Driven by consistent corporate and project strategies, objectives, and processes, the ability to execute successfully, and taking a comprehensive approach to value creation
2. Extensive and in‐depth project evaluation of the driving factors beyond project parameters and financial ratios to determine the likelihood of project success
3. Focus on key project development issues and critical success factors to ensure project viability and successful financing in order to achieve expected value creation for sponsors and customers
4. Emphasis on project management and financing organization skills and capabilities, processes, and critical and objective evaluations
5. Balanced treatment of all project stakeholder interests in cost and benefit assessment, risk allocation, negotiations, and contracts
6. A cost‐benefit based, holistic, and wide‐ranging approach with the objective of helping sponsors to strive to obtain a competitive advantage through project finance

1.6 STRUCTURE OF THE BOOK

It is generally accepted that infrastructure project finance in developing countries is a complex and difficult undertaking because of credit impairment and a number of other factors involved. Coming from the perspective of project finance for new business development, the intent is to expose the reader to all parts of project finance that are involved in creating successful projects of any kind. To begin with and in order to get a sense of those challenges and difficulties, the essence of project finance is presented in an overview summary of the subject in Chapter 2. The taxonomy of projects is shown along with key activities of project finance processes and SPC ownership and financing considerations. Also, common misconceptions and myths about project finance are presented and dispelled.

To get a better picture of the shortcomings and difficulties associated with project finance and the root causes of project failures, Chapter 3 reviews the record of project financing deals by industry and region and focuses on identifying the main failure factors with the intent to present some valuable lessons learned. One of the project failure reasons is process faults and gaps and Chapter 4 presents project finance process perspectives from different project participants that are indicative of differences in priorities which, if left unresolved, ultimately lead to project failures.

Before discussing project participants and their roles and responsibilities, the PFO is described in Chapter 5. The PFO is a crucial entity and part of the project team and its organizational structure, composition, and business definition are presented along with required PFO associate required skills and competencies. Also, the characteristics of successful PFOs and their contributions are discussed based on the author's experiences, project participant discussions, and findings of benchmarking. Next, the objective of Chapter 6 is to identify the essential parts of the most important elements in project finance. That is, to identify the preparations needed along with the planning and activities that take place in each phase of the project development process. These undertakings lead to obtaining cost estimates and revenue forecasts and driving projects down to sound evaluations and project financing structuring.

Chapter 7 is concerned with project participants and their roles and responsibilities, their objectives and requirements, and how they add value to the development and implementation of projects. We point out the potential for conflict of interest, the importance of an open mind; and unimpeded communication, coordination, cooperation, and collaboration (4Cs). The need for sound competitive analysis, industry and solid market research, persistence, and the balancing of interests is apparent. Due to the crucial importance of accurate project costs and revenue forecasts to project financeability and project viability, factors that determine appropriate forecasting techniques for project financing are discussed in Chapter 8. Sources of analog forecasts, development of assumptions, analyses and evaluations, and forecast sanity checks and sources of forecast failures are also discussed in this chapter.

The purpose, nature, and effects of project contractual agreements are explained in Chapter 9 for the reader to appreciate why project finance has sometimes been called contract finance. The discussion centers around the nature of common project finance contracts, prerequisites, and costs of project contracts as well as the process of contract development and negotiation. Additionally, the main challenges and success factors associated with project financing contracts are cited. On the other hand, how a good part of the work and decisions involved comes down to identifying, evaluating, allocating, and mitigating project risks are the subject matter of Chapter 10. The different types of risk and the use of the risk matrix and other techniques are discussed along with the costs and benefits of effective risk management, which is so important to project financeability. Notice that a crucial component of risk management is the network of contractual agreements that helps to ensure the project's economic viability.

The required project evaluations beyond the feasibility study are given proper attention in Chapter 11 to ensure project viability. Here, we discuss the due diligence process, assessments, techniques, and tools used to test, verify, and validate analyses and results. This is really a continuation of the discussion of the previous chapter and its focus is on the crucial undertaking of due diligence and preparation of its report. Although it is performed by lenders, the early and ongoing involvement of the project team to verify and validate important factors is required. It is because the project team is better informed of issues that outside experts are not in a position to see and it is in a better position to focus the due diligence on those issues. This also helps the sponsor team's objective to drive toward a competitive advantage. The processes and activities discussed in Chapters 11 and 12 are some of the most important areas of project finance organization participation and its contributions to ensure project funding and profitability and build a foundation for competitive advantage.

The different sources of financing for infrastructure projects and the different funding instruments and credit enhancements are covered in Chapter 12. The multilateral, ECA, and US government funding agencies and the support they provide, as well as private funding sources and instruments, are discussed in some detail. This gives an idea of the many options open to funding infrastructure projects. Notice, that many of those funding channels and instruments are available for many other types of projects beyond infrastructure. Next, the crucial element of project and financing structuring is the topic of Chapter 13. Its many elements, determinants, investor requirements, and the decisions and choices that need to be made from ownership structuring to financing structuring and related issues are explored in some detail. Furthermore, the decisive factors of project financing are highlighted and how the integration of various participant deliverables takes place in the financing plan is explained.

Chapter 14 deals with the development of input components, outputs and their use, and evaluations performed through the project financial model. That is because of its central role in determining the project company's funding needs, its ability to raise required funding, repay debt, and estimate the return on investors' equity. Next, Chapter 15 provides a sense of where the state of the project finance industry is headed. For that, we examine project financing trends as a complement to megatrends driving the industry and look at their impact on different project participants. Also, we examine how trends could affect project company operations and look at factors that determine a project team's ability to take advantage of trends and make required adjustments to reinforce progress toward competitive advantage.

Chapter 16 examines the issues of obtaining a competitive advantage through project finance and whether a sustainable competitive advantage can be created. The author's views and the findings of a benchmarking study of different project participants are shown. Participants included sponsors and developers, customers, commercial and investment bankers, ECAs, and multilateral agencies. Law firms, project finance advisors, contractors, and equipment suppliers were also solicited and their views serve as a means of reality and sanity checks on competitive advantage through project finance. The chapter ends with the conclusion that competitive advantage may be obtained through project finance and confirm the initial hypothesis that sustainable competitive advantage may not be long lasting except in a few instances. And, due to the large number of definitions and acronyms used in project finance, appendices A and B contain commonly used acronyms and definitions used in project finance to clarify their meaning.

1.7 USE OF THE BOOK TO MAXIMIZE BENEFIT

Experience from presentations of the book's material suggests that readers will best absorb the material presented, apply lessons learned, and maximize benefit by following the simple outline below:

1. Begin reading chapters with two ideas in the back of the mind:
   1. This is a new approach and a lot of material is presented from a broader perspective that needs to be gradually absorbed
   2. The apparent repetition is intended to clarify issues and orient the reader towards striving for competitive advantage, which is possible with the right mindset, objectives, and focus
2. Read each chapter to understand and make notes on how the material discussed can enhance the current project finance paradigm and help a company's project team move towards obtaining a competitive advantage
3. Continue reading and observe how the different analyses, evaluations, tests, and elements of business development and project finance are interconnected and help assess project viability effectively and affect funding efficiently
4. Record how each chapter's material helps screen, develop, evaluate, and structure a project effectively and how sound risk identification, assessment, mitigation, and comprehensive due diligence enable the project team to create profitable projects
5. Develop increased understanding of how the right project finance organizational structures and charters, skills and competencies, project objectives, processes, assessments and tests, contractual agreements, project financial model outputs, and financing plan decisions come together
6. Recall the roles and responsibilities of all project participants, the importance of managing their interests and expectations effectively, and the crucial role of project management in integrating different processes and deliverables
7. Assess whether an organization possesses what it takes to obtain a competitive advantage in project financing and if not, make extrapolations on how to go about getting there by following the concepts presented
8. Repetition is the mother of learning and application of lessons learned is certain to enhance project finance team effectiveness, avoid project failures all together, and result in more value creating projects