The term “project finance” is used loosely by academics, bankers and journalists to describe a range of financing arrangements. Often bandied about in trade journals and industry conferences as a new financing technique, project finance is actually a centuries-old financing method that predates corporate finance. However with the explosive growth in privately financed infrastructure projects in the developing world, the technique is enjoying renewed attention. The purposes of this note are to contrast project finance with traditional corporate financing techniques; to highlight the advantages and disadvantages of project finance and to propose that a single structure underlies every project finance transaction; to explain the myriad of risks involved in these transactions; and, to raise questions for future research.

Project financing techniques date back to at least 1299 A.D. when the English Crown financed the exploration and the development of the Devon silver mines by repaying the Florentine merchant bank, Frescobaldi, with output from the mines.

The Italian bankers held a one-year lease and mining concession, i.e., they were entitled to as much silver as they could mine during the year. In this example, the chief characteristic of the project financing is the use of the project’s output or assets to secure financing.
Another form of project finance was used to fund sailing ship voyages until the 17th century. Investors would provide financing for trading expeditions on a voyage-by-voyage basis. Upon return, the cargo and ships would be liquidated and the proceeds of the voyage split amongst investors.

An individual investor then could decide whether or not to invest in the sailing ship’s next voyage, or to put the capital to other uses. In this early example the essential aspect of project financing is the finite life of the enterprise. In corporate finance terms, we can also think of this mandatory liquidation as a fixed dividend policy. The idea of project finance predated the idea of permanent capital entrusted to a group of professional managers who would decide rather autonomously between paying dividends and reinvestment.
Project financing has evolved through the centuries into primarily a vehicle for assembling a consortium of investors, lenders and other participants to undertake infrastructure projects that would be too large for individual investors to underwrite.

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