Corporate finance and project finance are two different financing models. Both help investment banks meet their funding requirements. Both rely on equity and debt to source funds. The difference lies in the security each offers and the purpose behind availing them.
Corporate finance helps manage the overall finances of an investment bank. These include raising capital, financial modeling, and fund optimization. On the other hand, project finance refers to funding a specific project, including its assets and cash flows.
Specialists offering corporate and project finance support for investment banks know they have different purposes and meanings.
Let us try to understand them better.
Understanding Corporate Finance
In corporate finance, the investment bank consolidates the cash flows of all business segments and projects under a single head to ensure optimal use of the available capital and maximize shareholder value. The entire firm gets the share of risks and rewards associated with all segments and projects. The failure or success of each project affects the bank’s overall performance and directly influences the balance sheet.
If the borrower defaults, the lender gets legal claims on all the company’s assets. The company can benefit from positive cash flow from other successful projects. It is a suitable financing model for companies planning large expansions from various projects.
Understanding Project Finance
Individual projects are capital-intensive, time-consuming, and high-risk in nature. Project finance requires special techniques and skills depending on the project work. The investment bank infuses capital into individual projects based on their projected cash flow, taking project assets as collateral to secure the money.
The rewards and risks are ring-fenced, meaning that in case of a default, the lenders have a claim to limited assets only associated with the project. The lenders have no claim on the parent company’s assets.
The rewards and risks associated with one project do not affect other projects. Experts working on offering project finance support for investment banks ensure minimal impact on the company’s overall balance sheet.
Benefits of Project Finance Over Corporate Finance
Financing projects through project finance offers several benefits, including the following:
- An opportunity to share risks
- Extension of debt capacity
- Release of a free cash flow
- Competitive advantage in the market
Project finance is an ultimate financing source for companies that wish to fund a project off the balance sheet without a corporate repayment guarantee. It allows sponsors to extend their borrowing capacity, enabling financing the project on someone’s credit, including the project output’s final buyer. Sponsors can acquire the required funds based on specific contractual commitments.
Project finance allows sponsors to share the associated risks with stakeholders through contractual agreements, security arrangements, and additional credit support. It reduces the project company’s risk exposure and helps the lenders manage free cash flow. Since the project is limited, there is a minimal conflict of interest between the investment bank and the company’s management.
Despite all the advantages, project finance is quite costly and complex to assemble. Investment banks require expert project finance support to simplify the complexity and minimize the project costs for maximum benefit.