What is Due Diligence in Project Finance?In the project finance business, deal origination happens through the direct relationship that relationship managers across different sectors enjoy in the industry. Proposals are presented in the form of appraisal notes put up to either the credit committee or a committee of senior management, whichever is the appropriate sanctioning authority. Due diligence in project finance involves thoroughly reviewing all proposals engaged in a deal.An appraisal note ideally contains a write up on the company background, its management and shareholding pattern, its physical and financial performance, the purpose of the project being funded, details of costs involved and means of financing, the market for the company’s products, future prospects and profitability projections, risk analysis, and the terms and conditions of sanction.How is Due Diligence in Project Finance carried out?Due diligence in project finance is a process that consists of multiple steps to ensure the most comprehensive analysis:
- Assessment of promoter history and background
- Evaluation of the company and project business model
- Legal due diligence
- Analysis of financial statements and capital structure
- Determine significant risks associated with the project
- Analysis of tax effects
- Credit analysis and evaluation of loan terms
- Project valuation
- Assessment of group companies – Involves the in-depth study of various companies promoted by the sponsor. Evaluation of group companies is necessary even in cases where no direct support from companies to the project company exists. If the group is facing a severe financial crunch, the possibility of diversion of funds from the project company cannot be ruled out. The lenders need to take adequate steps to ring-fence the project revenues in such circumstances.
- Track record of sponsors – In case of any subsisting relationship with the sponsor, the track record of the sponsors should be studied in light of its association. The lender should identify any incidences of default and analyse the causes.
- Management profile of sponsor companies – Helps in assessing the quality of management. Lenders are typically more comfortable taking exposure with professionally managed companies.
- Study of shareholder’s agreement – Study of the shareholder’s contract should be done to get clarity on issues such as voting rights of shareholders, representation on the board of directors, veto rights (if any) of shareholders, clauses for the protection of minority interest, the procedure for issuing shares of the company to the public and the method of resolution of shareholders disputes.
- The management structure of project company – A study of shareholder’s agreement helps determine the management structure of a project.
Evita Veigas
4 min read