Biorefinery Project Finance Techniques
Project finance is a creative, sophisticated means to secure debt and other financial resources to construct major industrial facilities with minimum reliance on recourse to equity owners. The principal advantage of project finance is reducing the impact of the financing package on the owners’ balance sheet and other lending relationships. The techniques developed in project finance can be useful in the biorefining industry to finance capital-intensive projects like biorefineries, chemical plants and similar facilities. The key characteristic of project finance is that the “project” is intended to support the financing required for its construction and operation, without significant dependence on the balance sheets or guarantees of project equity owners. The equity participants might be a single owner, or two or more joint venture parties, typically with an interest in the plant’s feedstock or production. How the equity is divided is likely to depend more on input or off-take relationships and management or operating expertise than on actual cash invested, or land and equipment provided. The equity may be divided into classes having different interests and rights.
The debt financing is even more likely to be stacked with different rights and returns. Typically, one or more banks or financial institutions will provide long-term senior debt for a significant percentage of the as-built value of the asset, secured by a first mortgage on that asset. Subordinated debt of one or more tranches will enjoy a higher return based on the additional risk undertaken. Subordinated debt to finance equipment and working capital will most likely be secured by equipment, inventories and receivables. In each case, the lenders will focus principally on the anticipated cash flow of the project to sustain principal and interest payments on their loans.
The package may also include other financial resources or benefits integral to the enterprise’s financial viability, such as industrial revenue bonds, tax incentives, government grants and similar enhancements. Matching the requirements of the project with the applicable tax regime can be both challenging and productive. For instance, a major fertilizer plant was constructed in a manner to qualify as movable personal property to avoid being taxed as real property. The political dynamics and contractual arrangements need to be analyzed carefully to assure that government enhancements will remain in place for the duration of the project, or at least until the debt has been repaid.
Project cash flow will typically depend on long-term contracts to supply feedstock, energy and transportation, and to purchase outputs. The contracting parties could be other major players in the industry and could be one or more of the equity owners of the project. These supply or purchase agreements will normally remain in place for the duration of the project or financing, subject to some latitude for adjustments if circumstances change. If one party is on both ends of the production stream, a tolling agreement might be considered. Management or operating agreements will be required. In all cases, the lenders will evaluate the strength and staying power of the contracting parties because they will inevitably be the source of the cash flow required to service the debt. If the equity owners are parties to these agreements, they will indirectly provide some measure of guarantee.
The lenders will insist on several financial and operating covenants in their loan agreements. Both the project developers and lenders will need to assess the likelihood of noncompliance with covenants and the consequences of failure or default on the part of the project. Lenders may require limited recourse to equity participants or contracting parties in the event the project’s ability to meet its obligations is threatened. Although separate lending agreements may be carefully drafted between each financing source and the project, intercreditor agreements are advisable to clarify the differing rights of the lenders among themselves.
Bringing all of these pieces together requires lengthy and detailed planning. Financial projections will be essential, including highly credible construction and equipment cost figures and operating forecasts buttressed by long-term agreements. The plant location will determine the availability of grant and tax benefits and the operating and tax expenses to be incurred. A detailed schedule or critical path from planning stage to operations will guide the process. The team required to accomplish planning will include finance, operations, sourcing and marketing, legal and accounting representatives. Interdependent agreements will address everything from construction to asset ownership upon debt repayment. Variables will make almost every project unique; imagination and flexibility will be essential. Early discussions with financing sources will be important to assure a realistic plan. The conceptual phase isn’t too early to approach potential financing sources. Outside advisors will bring expertise to the table to produce a financing package that will be viewed favorably by potential lenders.
Author: Dean R. Edstrom
Partner Attorney, Lindquist & Vennum