To discuss the difference between corporate finance and project finance, we must first look at these two differently, look at their similarities, before delving into their differences.
What is corporate finance?
Corporate finance is the funding of a corporation’s (the borrower or debtor):
- consolidated projects for another entity (the project owner), and/or
- internal operations
Here, the borrower may engage the lender to become part of the company, such as becoming a shareholder.
What is project finance?
Project finance is the funding of large-scale and long-term projects, such as infrastructure projects and other industrial undertakings.
Here, a corporation (the borrower or debtor) loans funds from another entity (the lender or creditor). The loaned amount will be used to complete the project of another entity (the project owner).
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What is the difference between corporate finance and project finance?
Corporate finance and project finance are both financing models which address the financial needs of an enterprise, corporation, or any other entity.
There are differences between corporate finance and project finance:
Usage
Corporate financing is used when an entity is being established or when it pursues expansion. It calls upon other entities to fund or support the internal operations of the emerging entity.
Project finance, on the other hand, is used to seek out financing when it engages in new projects. As such, the financed amount is used not for the entity’s operations, but to implement a project owned by another.
When an entity needs finances for short-term uses, it usually resorts to corporate financing, since this will only address an immediate liquidity problem of the entity.
If it needs finances for long-term use – such as when financing an infrastructure project – project financing is used. Project finance applies to projects with larger financial needs.
Consequences
Corporate financing involves equity and debt financing. As a result, personalities who supported the borrowing entity through corporate financing become investors or shareholders of the borrowing entity.
Such is not the case for project financing. Here, what is established is that of a debtor-creditor relationship – where the debtor is the borrowing entity, and the creditor is the financing entity.
While corporate finance may be “short-term” in view of its usage, the capital extended to the borrower is permanent in nature. This means that it continues throughout the life of the company, since the “lenders” have now become investors or shareholders of the borrower’s company.
Although the capital extended to project finance is “long-term” because it’s used for a project that ends after a long period of time, it’s still for a set period. The capital ends when the project ends.
Read more: What is a DSRA in project finance?
Credit valuation
One of the differences between corporate finance and project finance is the way the lender does credit valuation on the borrower. Before the lending entities loan money to an entity, they will first evaluate the creditworthiness or credit standing of the borrower.
In corporate finance, lenders look at these factors when assessing a borrower:
- Balance sheet
- Cash flow
- Financial stability
In project finance, the following are used in credit valuation of the borrower and the project:
- Feasibility study report of the project
- Asset value of the borrower
- Projected income of the project
At the outset, corporate finance uses the borrower’s internal financial strength, while project finance uses the proposed project’s viability in addition to the borrower’s internal financial strength.
Collateral
In both financing methods, collaterals are necessary before the loan amount is released.
It is on what assets are used as a collateral that corporate finance and project finance differ:
- Corporate finance: the borrower’s assets and cash flows are used as collateral
- Project finance: the project’s (not the borrower’s) assets and cash flows are used as collateral
Risks
There are two perspectives of risks in looking at the difference between corporate finance and project finance:
- Risks on the internal operations or the project’s success
- Risks of the lender being paid
Internal and project risks
The first risk looks at the segregation of borrower’s internal operations and its project’s success.
In corporate finance, since a project and the borrower’s overall operations are merged, a project’s failure may adversely affect the company operations.
Such is not the case with project finance. A project’s performance and management are segregated from the borrower’s internal operations. This process of segregation is also called “ring-fencing”.
Lender’s risks
Related to the first risk, the second type of risk refers to the lender being paid the amount it loaned to the borrower.
For corporate finance, this risk is relatively higher. Since the borrower will be using it for its internal operations, the entire entity of the borrower must be successful so that it will have enough resources to pay the lender.
For project finance, this risk is much lower because the lender is assured that once the project is completed, there will be revenues that can be used to pay the lender.
Although, these are all projections (hence, a “risk”).
Return-of-Investments
The return of investments (or ROI) in corporate finance and in project finance will usually depend on the risks. Typically, the higher the risks, the higher the ROI. However, the actual ROI will also be affected by various factors.
The ROI in corporate finance may be higher since the risk is higher, but it can still be much lower compared to project finance.
ROI in project finance will depend on the actual cash flow of the finished project.
Another difference in terms of ROI is that in project finance, there is a clear revenue as basis for the ROI.
To understand more about the difference between corporate finance and project finance, ask the best project finance lawyers in Canada as ranked by Lexpert.