It is sometimes claimed that an additional merit of leasing is that it provides
100% ﬁnance: this is correct in the sense that 100% of the cost of the equipment
being ﬁnanced is covered; however, this does not mean that 100% of the project’s
overall costs are ﬁnanced:
• Lease ﬁnance is unlikely to be available to pay for land acquisition.
• Tax leasing for buildings is usually less attractive than leasing of equipment.
• “Soft” costs such as development costs and interest during construction are of-
ten not covered—and thus even if no other debt is raised investor equity will
still be needed. Furthermore, the loss of the residual value of the equipment
which may occur with some lease structures is an additional hidden cost.
“Synthetic” leveraged leases have been used for some project ﬁnance transac-
tions in the United States. These are leases that for tax purposes transfer owner-
ship and hence tax beneﬁts to the lessee (thus leaving the lessee in the same posi-
tion for tax purposes as a borrower), but for accounting purposes are treated as
off-balance-sheet “operating” leases, i.e. leases where ultimate economic owner-
ship theoretically lies with the lessor, because the lessee has the right to return the
equipment after a period of use, although in reality this right will not be exercised.
(To make the return option unattractive, at the end of the lease period the lessee
may either have to renew the lease or exercise an option to purchase the equipment
for the outstanding debt and lease equity; if neither of these happens, the lessee
must pay a large lump-sum rental payment and the equipment is sold.) This type
of lease ﬁnance may be used as a way of manipulating reported earnings, if the
lease rental payments in the early years of the project are structured to be lower
than the total of accounting depreciation (cf. §12.7.1) and interest payments on a
loan, while minimising tax payments. It is therefore more suitable for relatively
short-term ﬁnancing (typically up to 5 –7 years) during construction and early op-
eration of a project, which may then be reﬁnanced. It has been especially used for
“warehousing” gas turbines which have been ordered in advance for use in power
In summary, however, lease ﬁnance is a “bolt-on” to the basic ﬁnance structure
whose primary merit is a reduction in ﬁnancing costs, or an improvement in re-
ported earnings; it does not change the fundamental approach to the ﬁnance by ei-
ther Sponsors or ﬁnanciers.
§3.5 VENDOR FINANCE
In some cases, ﬁnance may be offered by a seller of equipment, an EPC Con-
tractor, or a supplier of services to the project (a vendor in this context). An equip-
ment supplier, for example, may have a better understanding of the technical risks
of the project, or of the industry concerned, than a commercial lender, and there-
30 Chapter 3 The Project Finance Markets