Financing Needs of Infrastructure Projects at Different Stages
Infrastructure projects typically last for many years. It is not uncommon for these projects to last for decades. These long term projects have different phases. Each of these phases has unique needs from a finance point of view, as well. In this article, we will explain how the financing needs of an infrastructure project depending upon the phase of the project in question.
Phase #1: Planning
Infrastructure projects are not executed overnight. Since there is a large outlay of capital and many different parties are expected to work together, the planning of these projects is very detailed. During the planning phase, the deliverables and the dependencies of all the stakeholders are examined. Then all the parties try to negotiate to obtain more time or more resources in order to execute their part of the project better.
As a result of this constant back and forth, it is not uncommon for the planning phase of any project to last anywhere between 15 to 30 months! The long term financing of the project happens during this phase.
Usually, the project planning authority finds equity investors. Generally, equity investors are stakeholders who have some sort of technical expertise required for the project. These equity investors are then entrusted with the task of finding debt investors for the project.
At this stage, it is difficult to float any bonds in the open market. This is because cash flow is going to materialize at a later date, and also such projects are rife with uncertainty. This is the reason that debt financing at this stage is almost exclusively done by banks. In fact, any single bank is also not willing to take up all the risk during this phase. Debt financing at this stage is commonly provided by a syndicate of banks.
Phase #2: Execution
This is the longest phase of the project. Here, the various stakeholders are supposed to put the agreed-upon plan into action. It is common for delays to happen during this phase. Delays could be because of the negligence of the parties involved.
Alternatively, delays could also be because of factors that are beyond the control of the stakeholders viz. legal hassles. It is important to draw up contracts in order to punish shoddy work.
The proper execution can be ensured by assigning penalties such as demurrages for delayed execution or poor quality work. However, as far as factors beyond the control of the stakeholders are concerned, the only way is to ensure that additional funds have already been allocated to meet contingencies. Also, insurance can be taken to limit the loss arising from such a delay.
From a finance point of view, this is the most high-risk phase of the project. This is where all the negative cash flow sets in. Also, this is where mismanagement of the project by different stakeholders could have a huge impact on the equity investors.
It is important to choose debt investors who can provide additional capital at this stage if required. If a company tries to obtain additional capital from the market at this stage, they will have to pay a hefty premium. This is because investors will be of the opinion that the project has run out of cash since the planning has already failed. Therefore the project will be perceived as a high-risk project even though it may not be the case.
At this stage, it is also difficult for both equity as well as debt investors to exit the project without taking a financial loss. This is because there are only a handful of other companies that may have the resources to take over such a project. Each of them may be looking for a significant discount to take over the project in the middle. Once again, this may be due to uncertainty.
Phase #3: Operations
This is the stage when the project has been completely executed. At this stage also, the project is cash flow negative. However, since the cash flows have already started showing, the risk of default reduces to a huge extent.
This is the stage where either debt or equity investors can exit the project by offloading their stake in the open market. Since the project is now a going concern, individual investors start investing in it.
For instance, it is common for banks to securitize their exposure to the project at this stage and sell bonds on the open market. This means that if a bank wants to liquidate $100 worth of investment in the project. They can create 100 bonds of $1 each and exit the project.
If the debt investor doesn't want to sell bonds or other securities, a simple refinance arrangement can be made. Since the risky phase of the project is over, it makes sense to reduce the cost of capital so that the additional money can be diverted to increase the profits of the equity shareholders.
The bottom line is that infrastructure projects can have very different financing needs at different stages of the project. There are some tried and tested policies which need to be followed at different stages of the project. Financial innovation should also ideally be done within the framework of these policies.
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The article is Written By “Prachi Juneja” and Reviewed By Management Study Guide Content Team. MSG Content Team comprises experienced Faculty Member, Professionals and Subject Matter Experts. We are a ISO 2001:2015 Certified Education Provider. To Know more, click on About Us. The use of this material is free for learning and education purpose. Please reference authorship of content used, including link(s) to ManagementStudyGuide.com and the content page url.
- Infrastructure Finance: An Introduction
- Infrastructure as an Asset Class
- Infrastructure Finance Projects: Major Sources of Funding
- Why Doesn’t the Private Sector Invest In Infrastructure Projects?
- The SPV Structure in Infrastructure Finance
- Financing Needs of Infrastructure Projects at Different Stages
- Different Types of Contracts for Infrastructure Projects
- Distribution of Risks in an Infrastructure Project
- Risks Faced By Infrastructure Projects in Emerging Markets
- Bank Loans vs. Bonds: Debt Financing In Infrastructure Projects
- Key Decisions to Be Taken During Infrastructure Bond Issuance
- Parties Involved in Infrastructure Debt Issuance
- External Credit Enhancement in Infrastructure Financing
- Revenue Bonds and the Cash Trap Mechanism
- Managing Revenue Risks in an Infrastructure Project
- Cost Overruns in Infrastructure Projects
- Causes for Cost Overruns in Infrastructure Projects
- Third-Party Risks in an Infrastructure Project
- Vendor Finance in Infrastructure Projects
- Securitization in Infrastructure Finance
- Leasing in Infrastructure Finance
- Strategic Use of Land in Infrastructure Financing
- Usage of Collateralized Debt Obligations (CDO) in Infrastructure Finance
- Infrastructure Investments in Renewable Energy
- Should the Government be an Equity Partner in Infrastructure Projects?
- Lifecycle of Public Private Partnership (PPP) Projects
- Payment Mechanisms in Public-Private Partnerships
- Adjustment Mechanisms in Publich-Private Partnership (PPP) Contracts
- Early Termination of a Public Private Partnership