Project Finance vs Private Equity
Let’s say that you are just starting in learning finance, and you have heard about both of these – Project Finance and Private Equity. You have mixed feelings about these careers. As they are in the finance domain, you feel that no matter what, you would love each of these. But is it? We will bust some myths and show you how you need to approach your career in these two completely different subjects.
Here’s the flow we will follow – we will first talk about why you should study both of these subjects (both are very vast in scope and opportunities); then we will define both of them; then we will discuss important concepts in each of these subjects; then we will talk about the compensation, education and work-life balance; and finally we will do a comparative analysis between these two.
Let’s bust the confusion and slake your thirst for knowing these two in little more detail.
#1 – Why study Project Finance or Private Equity?
Project finance is an art of financing the project, often quite large from different sources of funds. So if you know project finance, it would help you understand how the whole process is being taken care of. Suppose you join a bank after you study and see that your bank works as a financier for a project management company. You need to know in greater detail how the bank will decide to invest in the project or not invest. The bank will see the projected cash flow through financial modeling, and then if the projected cash flow seems satisfactory, only will sanction the loan. You also need to know what collateral the project management company will keep as mortgage as they can’t mortgage their company assets.
In the case of private equity, you need to be pretty good with investment analysis. In private equity, you are part of a firm where many investors will come together to invest in a worthy business. So you can understand that many businesses need funding. But a private equity firmPrivate Equity FirmPrivate equity firms are investment managers who invest in many corporations' private equities using various strategies such as leveraged buyouts, growth capital, and venture capital. The top private equity firms include Apollo Global Management LLC, Blackstone Group LP, Carlyle Group, and KKR & Company LP. will only invest in a business where the ROI is highest. You need to know to do comparative investment analysis so that you can figure out how many opportunities cost you are incurring as a result of deciding to invest in a particular business. Often people confuse investment banking and private equityInvestment Banking And Private EquityInvestment banking is the financial mechanism through which a person receives financial advisory services from the investment banker regarding the share capital. In contrast, private equity funds are investment funds that pool funds from different investors with high net worth to acquire stakes in different entities., but both are different. In investment, the banking consultant arranges funds for businesses/clients. Investment banking is a capital raising service. Whereas, private equity firm invests; as a part of the analyst team in private equityAnalyst Team In Private EquityA private equity analyst is an analyst who looks for undervalued companies for a private equity investor to buy, take them private and earn profits. The companies are primarily unlisted, and the risk is higher. firm, your job is not to advise but to invest.
Studying these two subjects will give you typical concepts and knowledge about these two kinds of sub-domains of finance. And both are very much prevalent in our business world nowadays.
#2 – Project Finance vs. Private Equity – Meaning
What is Project Finance?
Project finance is useful when a firm/s decide to start a large project, usually an industrial or renewable project. Any project needs funding. At the beginning of the project, there are no assets. So how would the loan be arranged? The financiers or the sponsors (often equity investors) decide to see the projected cash flow of the project and then invest based on the projected cash flow. Now, what if the project doesn’t earn that much cash flowCash FlowCash Flow is the amount of cash or cash equivalent generated & consumed by a Company over a given period. It proves to be a prerequisite for analyzing the business’s strength, profitability, & scope for betterment. as projected. How would they pay the amount invested in the project? To solve this issue, the project assets which are being used in the project are used as collaterals. If by any chance, the project doesn’t earn that much cash flow and thus is not able to pay off, then the project assets are taken over by the financiers or sponsors.
Now, the above is just an overview of project financeProject FinanceProject Finance is long-term debt finance offered for large infrastructure projects depending upon their projected cash flows. Moreover, an investor has to form a Special Purpose Vehicle (SPV) to acquire the same. . There is much nitty-gritty of this. Many parties and documents are used as a part of the process, which you will get to know in the later sections.
What is Private Equity?
There’s no doubt about it that private equity is completely different than project finance. In the case of private equity, there are usually four functions. The first and most important function is fundraising. Normally fundraising is being done by the senior associates. But as juniors also, there are ample opportunities to analyze past performance, past investors, and the strategy used in the past. Often, as junior associates, you need to do credit analysisCredit AnalysisCredit analysis is the process of drawing conclusions about an entity's creditworthiness based on available data (both quantitative and qualitative) and making recommendations about perceived needs and risks. Credit analysis also involves identifying, assessing, and mitigating risks associated with an entity's failure to meet financial commitments.. The second function is screening. In screening, the junior associates take pivot roles. They look for all the opportunities and screens by using financial models (DCF Valuation, Net Present Value method, etc.). They see whether investing in these projects would be profitable or not. The third function is managing investments and portfolios. Associates help to turn around operations and help increase operational efficiency (EBITDA, ROE, etc.). Lastly, private equity associates also work on their fourth main function, and that is to analyze the exit strategy that needs in-depth analysis.
Private equity associates need to be thorough with financial models. They also need to have in-depth investment knowledge and be aware of the market changes now and then. Go for this profession if you have a knack of analysis and a passion for investment in a broader sense.
#3 – Important Concepts
In this section, we will learn a few concepts in project finance and also get to know about the parties involved and documents required.
- Project development: Project development is one of the most important concepts you need to know. As project finance is all about funding in a project in a sequential manner. So it’s important to know the stages of project development –
- Pre-bid stage
- Contract negotiation stage
- Money-raising stage
- Parties involved: There are many parties involved in project finance. Let’s look at all these parties in brief –
- Sponsors: People who sponsor the project, often equity investors.
- Lender: Financial institutionsFinancial InstitutionsFinancial institutions refer to those organizations which provide business services and products related to financial or monetary transactions to their clients. Some of these are banks, NBFCs, investment companies, brokerage firms, insurance companies and trust corporations. that lend money for the project
- Financial advisors: They help the parties to understand how much return on investment they can make. They can be on both sides – lenders or borrowers.
- Technical advisors: Often, for effective execution of the project, technical consultants are hired. They act as technical advisors for the project.
- Legal advisors: As the name suggests, they help in legal matters.
- Debt Financier: People who give secured loanSecured LoanA secured loan is one where the borrower pledges his/her assets as a collateral to the issuer as a security. In the event of nonpayment of the loan, the issuer has the right to sell or transfer the secured property in order to recover the balance owed. for the project based on project assets.
- Equity Investors: People who invest the money instead of shares
- Regulatory agencies: Generally, government authorities who take care of the regulations regarding the project intricacies.
- Multilateral agencies: The agencies are part of the World Bank group.
- Document required: There are a few documents that are of utter importance. Let’s have a look at them –
- Shareholder/sponsor documents
- Finance documents
- Project documents
- Other project documents
- Financial Models: Before investing, any investor would like to know how their money would be recouped. Similarly, the sponsors, when they are requested to invest in a project, they need to know how the project will do. Thus they hire people who can calculate projected cash flow so that they can understand the merit of the project and how much ROI they can expect out of it. And the projected cash flow is calculated through financial modeling. Financial modelingFinancial ModelingFinancial modeling refers to the use of excel-based models to reflect a company's projected financial performance. Such models represent the financial situation by taking into account risks and future assumptions, which are critical for making significant decisions in the future, such as raising capital or valuing a business, and interpreting their impact. is just a spreadsheet comprises of important calculations.
There are few concepts that will give you a hint of what you can expect under private equity as you learn more about private equity. Let’s have a look –
- Private equity investors: In general, investors who invest in the business in place of the ownership of those businesses will be called as private equity investors.
- Angel Investors: Investors who invest in start-ups and often very risky business are named as angel investors. Angel Investors often take a major role in the company after they invest.
- Venture Capitalists: Venture capitalists are a group of investors who pool their money and invest in private businesses. Do check out the difference between Private Equity and Venture Capital
#4 – Project Finance vs. Private Equity – Compensation
As project finance professionals, your compensation is huge. On average, a project finance professional gets around the US $100,468 per annum. But you need to arrange everything from top to bottom. You will have very fewer options to delegate the tasks as if there’s even a little discrepancy; then, you would be answerable to your seniors. To be a project finance professional, you need to have a few years of experience before taking charge.
In private equity firmsPrivate Equity FirmsPrivate equity firms are investment managers who invest in many corporations' private equities using various strategies such as leveraged buyouts, growth capital, and venture capital. The top private equity firms include Apollo Global Management LLC, Blackstone Group LP, Carlyle Group, and KKR & Company LP., if you work as an associate, you get paid well. And it is as lucrative as investment bankingInvestment BankingInvestment banking is a specialized banking stream that facilitates the business entities, government and other organizations in generating capital through debts and equity, reorganization, mergers and acquisition, etc. professionals. Depending on how much value you bring to the market place, your compensation ranges from the US $100K – $220K per annum. There is no wonder why many finance professionals are aiming to be hired by private equity firms.
#5 – Project Finance vs. Private Equity- Education
The pre-requisite to be a project finance professional is to have a knack for analysis and solving problems that may arise out of no-where. Along with that, you need to do your MBA in Finance from a reputed institute. After going through the top 25 project finance profiles in India, we have concluded that an MBA is a must to reach higher in an organization that helps build projects. Other than that, if you have any background in Chartered Accountancy, Cost AccountancyCost AccountancyCost accounting is a defined stream of managerial accounting used for ascertaining the overall cost of production. It measures, records and analyzes both fixed and variable costs for this purpose. or have a degree in Law and have an MBA from a sought after B-School, you will create magic in the world of project finance.
Private equity professionals need to have more knowledge of investment. Thus, if they do an MBA in Finance, that’s good. But they need some value addition as well. The best course to pursue, if they want to be the topmost professionals in private equity, would be CFA. This course is so well designed that it is regarded as the best course for anyone who wants to thrive in the investing profession. CFA is not an easy exam to pass. But if you are committed to making your mark as a private equity professional, you will clear it in due time. Remember, commitment is the key.
#6 – Project Finance vs. Private Equity- Work-life balance
In project finance professionals, the work pressure is much more than a normal 9 to 5 professional. As project finance professionals need to handle multiple things simultaneously, they need to invest a minimum of 12 hours a day or even more. Normally, rarely do they work at weekends, but they may need to work if any crisis arises and they need to solve the issue immediately. Thus, project finance professionals maintain a good work-life balance.
Private equity associatesPrivate Equity AssociatesA Private Equity Associate assists other senior associates and partners in identifying a well-suited target to invest in and reaping the benefits by selling it at a profit, as well as overseeing due diligence, handling communication, and preparing financial models. also invest 12 hours a day working. Usually, they don’t work at the weekend, and very rarely do they need to be present all night for the analyses. So their work-life balance is also taken care of. They get enough time to mingle with their families and practice a hobby or two.
Comparative Analysis – Project Finance vs. Private Equity
Let’s look at some of the differences between project finance and private equity –
- The main difference between private equity and project finance is a matter of context. Project finance helps projects thrive, whereas private equity helps businesses (usually the best, not always) reach the top.
- A project is often financed by private equity investors. So there is a direct link between project finance and private equity, where both serve the same purpose.
- Private equity is not limited to only project finance. The investors also invest in thriving or start-up businesses depending on the marketability of the idea and the value the businesses are bringing on the table.
- Private Equity in Russia
- Private Equity in India
- Corporate Finance vs. Project Finance Differences
- Equity Research vs. Private Equity
In the final analysis
Both of these subjects are vast, and they have ample career opportunities. Ask yourself – “What’s most interesting to me?” and “Why?” If you’re able to answer these two questions clearly, you will be able to choose a career you would be proud of in the near future.