Leveraged buyout (“LBO”) or management buyout (“MBO”) ﬁnancing.
This highly leveraged ﬁnancing provides for the acquisition of an existing
business by portfolio investors (LBO) or its own management (MBO). It
is usually based on a mixture of the cash ﬂow of the business and the value
of its assets. It does not normally involve ﬁnance for construction of a new
project, nor does this type of ﬁnancing use contracts as security as does proj-
Acquisition ﬁnance. Probably the largest sector in structured ﬁnance, acquisi-
tion ﬁnance enables company A to acquire company B using highly leveraged
debt. In that sense it is similar to LBO and MBO ﬁnancing, but based on the
combined business of the two companies.
Asset ﬁnance. Asset ﬁnance is based on lending against the value of assets
easily saleable in the open market, e.g., aircraft or real estate (property) ﬁ-
nancing, whereas project ﬁnance lending is against the cash ﬂow produced
by the asset, which may have little open-market value.
Leasing. Leasing is a form of asset ﬁnance, in which ownership of the asset
ﬁnanced remains with the lessor (i.e., lender) (cf. §3.4).
§2.5 WHY USE PROJECT FINANCE?
A project may be ﬁnanced by a company as an addition to its existing business
rather than on a stand-alone project ﬁnance basis. In this case, the company uses
its available cash and credit lines to pay for the project, and if necessary raise new
credit lines or even new equity capital to do so (i.e., it makes use of corporate
ﬁnance). Provided it can be supported by the company’s balance sheet and earn-
ings record, a corporate loan to ﬁnance a project is normally fairly simple, quick,
and cheap to arrange.
A Project Company, unlike a corporate borrower, has no business record to
serve as the basis for a lending decision. Nonetheless, lenders have to be conﬁdent
that they will be repaid, especially taking account of the additional risk from the
high level of debt inherent in a project ﬁnance transaction. This means that they
need to have a high degree of conﬁdence that the project (a) can be completed on
time and on budget, (b) is technically capable of operating as designed, and
(c) that there will be enough net cash ﬂow from the project’s operation to cover
their debt service adequately. Project economics also need to be robust enough to
cover any temporary problems that may arise.
Thus the lenders need to evaluate the terms of the project’s contracts insofar as
these provide a basis for its construction costs and operating cash ﬂow, and quan-
tify the risks inherent in the project with particular care. They need to ensure that
project risks are allocated to appropriate parties other than the Project Company,
or, where this is not possible, mitigated in other ways. This process is known as
§2.5 Why Use Project Finance? 13
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