Lending 101: 5 Similarities between Venture Debt and Project Financing

1) The process of "building": Project financing usually covers the construction of a hard asset from zero to one. It can be infrastructure, real estate, utilities, power generators, etc. This means that at the onset of this deal, the underlying "asset" is still a work in progress and doesn't generate enough cash flow to service the loan. Similarly, for cash-burning tech companies, profitability is temporarily sacrificed to boost growth. We normally see the company doubling down in building out the R&D and sales team, and creating a lag in revenue generated vs expense incurred. The assets being built are usually intangibles (e.g. software) instead of hard assets. At the end of the day, both types of financing eventually return to cash flow lending. Project financing is evaluated based on the profitability generated when the asset is put to use; venture debt lenders expect that the company has visibility into generating positive cash flow.

2) Importance of Sponsor: Because of the unique nature of Project Financing (immaterial asset, no cash flow), sponsors are evaluated very closely. Rating the Project Sponsor is the number one criterion in rating the project. When we finance a cash-burning tech company, identifying and evaluating the deal sponsors are equally important as evaluating the company itself. A sponsor with a deep pocket, a past track record of successful project execution, and a historical pattern of standing by their projects/investments are key credit considerations. Skin in the game is also an important criterion - for both types of financing, the more capital the sponsor put in, the higher the commitment the sponsor showed in the deal, and the higher the chance that a sponsor's support would be expected in a distressed scenario.

3) Complexity of the project vs. tech stack: The more complex the project, the higher the execution risk and credit risk. For the tech stack, the more unique/disruptive the technology is, the higher the chances of building out a moat in the market and of success. Most of the time in Project Financing, lenders will engage professional engineers to evaluate the project complexity by way of providing a Lender's Technical Advisor (LTA) Report, but a technology audit is only performed when it involves highly complicated and advanced technology that bankers cannot reasonably evaluate.

4) Credit enhancements: Project Finance (typical in P3 projects) usually has insurance bonds (labour/material/project delay) in place to mitigate potential losses that may arise when disputes and other unforeseen incidents happen. Similarly, venture debt lenders sometimes work closely with partners (like EDC) who can provide quasi "insurance" through their different programs to help lenders get comfortable and reduce the expected loss in a default scenario.

5) Financing tied to milestone achievements: Project Finance disburses funds based on accomplishing different construction milestones. Venture debts are usually structured in a way that the company can gradually get increased in funding with demonstrated growth, it can be a margining against monthly recurring revenue, accounts receivable/inventories, or sometimes through equity raise.

Overall - to boil down the key consideration factors for Project Finance, ultimately the lenders strive to ensure that the project is executed on time and within budget. If we apply the same concept to venture debt, it is also to ensure the cash-burning company is achieving profitability at the right time (project executed on time) and to grow and control burn as planned (project executed on budget).