When a company wants to build a wind farm, for example, it might borrow the money from a bank. But that involves risks for the entire company, if the project doesn’t work out. What if the company wants to limit the risk of the project to no more than the investment it makes in the project? This is how project finance works.
“At the heart of project finance is risk distribution,” says Paloma Perez de Vega, who heads project finance for areas outside the EU at the European Investment Bank.
Paloma explains on the latest episode of A Dictionary of Finance podcast that “project finance is a means of financing large infrastructure and industrial projects where lenders rely on the forecast cash flows of a project rather than the balance sheet of a company” to assess their risk.
One way of accomplishing this is by using a special purpose vehicle. Peter Jeffreys, deputy head of project finance for Northern, Central and South-Eastern Europe at the EIB, tells the podcast that a special purpose vehicle is “a company set up for an individual purpose and that exists with the sole purpose of conducting the project throughout its life.”
Some of these projects involve public private partnerships. You can also check out our episode on these PPPs, which is called “The Secret Life of Infrastructure.”