Project finance is a type of financial structuring technique used to fund infrastructure and other long-term, capital-intensive projects. Projects such as wind farms, energy plants, roads, and bridges are often funded this way. Project finance structures involve a consortium of lenders who finance a particular project over a specified period of time and in exchange receive a return once the project is completed and operational.

The lender uses specific financial agreements and legal documentation to protect their investment and make sure the project’s generation of income is sufficient to make the repayment. As such, project finance involves no or limited recourse financial structure. This means that the responsibility of repaying the debt rests on the project itself and not on the sponsor’s personal assets.

In a non-recourse loan structure, if the borrower defaulted, the lender could seize and repossess the project’s assets, but the sponsor of the project cannot be pursued for additional payments beyond the seizure of project assets. Project debt is typically held in an isolated, non-consolidated subsidiary and thus is kept off of the sponsor’s balance sheet.

Project finance generally carries a higher-than-average investment risk because of its unique funding arrangement. To offset the risk, the lender and the borrower must understand and agree on terms like the cost of construction, risk management, and operational efficiency. To minimize investments risk, the lender sometimes requires the borrower to provide additional backing from the overall project, such as a personal guaranty or collateral.

As with all investments, it’s important to recognize the inherent risks associated with project finance and only invest if confident that suitable returns can be generated over the length of the projects. Project finance often produces high returns and allows investors to take advantage of long-term project opportunities. As long as the risk is managed and returns are met, project finance can be an ideal funding solution for large scale, capital-intensive projects.