Critical late-stage prep before approaching investors
Financing, Operating, Governance: The 3 Pillars of a Solid Project Structure
For a while now, notes have been focused on the mid-stage of project development, so to recap at the end of mid-stage, you should have:
Confirmed offtake reflected in detailed commercial demand and pricing estimates and studies
A technical design that covers the project’s requirements and is deemed suitable under environmental and social best practices and regulations
A detailed risk matrix that identifies, allocates, and mitigates risks
Identified and selected credible parties.
Drafted and substantively negotiated agreements with EPC, O&M, Suppliers, and Off-takers as applies to your project.
Secured Land access rights – by long-term lease or outright purchase under a deed properly registered with the appropriate authorities.
Be fully compliant or on track to be fully compliant with necessary pre-construction and operating permits and licenses at the Industry, Corporate, and Project level
A duly approved or on track to be approved ESIA, ESMP
Secured insurance for major aspects of the construction program, goods in transit for materials to be delivered, and other relevant insurance
Have a detailed financial model that reflects the Demand, Operating requirements, Technical Design that meets those requirements, a CAPEX estimate for said design, and an estimate of project revenue, costs viability and profitability.
Now you are almost ready to approach investors to commence their process of due diligence on you and your project to determine if and under what terms they will invest in the project.
Almost, because there is a brief but important late-stage of project preparation where project ownership and structure must be clarified, and proper advance preparations made prior to engaging investors.
If your project will be corporate financed against an existing robust corporate balance sheet that can act as collateral for debt, or you can inject substantial new equity into your existing corporate structure, draft or update your business plan, prepare your investor memorandum, and then proceed to shop for investors.
BUT if it will be project financed – where recourse is first to project cashflows, then the project's structure matters a lot, and part of your project preparation includes taking the time to understand, define, assign, and separate each major role in the project structure.
The capacity of all assembled parties to finance, deliver, and sustain the project, ensuring it will truly produce the cash flows that cover its operating costs, pay back loans and interest, and provide returns at or above the target IRR, matters a lot
The separation of roles and responsibilities, and clear project governance, also matter a lot.
This note on project structure is covered from two angles
1) What you need to do before approaching investors
2) What you need to be ready to discuss with investors when negotiating terms.
The SPV: A separate legal identity at the centre of the structure
Project Structure refers to the agreements that define the ownership, financing, responsibilities, and rights and obligations of the project SPV.
Therefore, before covering the project structure, let's cover the SPV, which is at the heart of a project finance transaction.
Special Purpose Company (SPC) or Special Purpose Entity (SPE) can be used also.
The SPV is created as a separate company distinct from the project sponsors' (equity providers') existing businesses. It is a single-purpose financial and legal entity, having no previous assets or obligations or business beyond the scope of the specific project it is designed to develop, own, and operate.
It is a clean balance sheet, ring-fenced from the existing balance sheets of its sponsors.
This "ring-fencing" ensures that the project and its cash flows are delineated and, theoretically, and if needed, entirely controllable by creditors.
The rationale behind creating an SPV is primarily to facilitate "off-balance-sheet" financing for sponsors, where they can receive "non-recourse" from lenders.
In principle, “non-recourse” means that lenders look only to the net cash flows generated by the stand-alone project for repayment, and to the project's assets only as collateral in the event of default, with no claim (recourse) to the sponsors’ other assets.
In practice, it is actually “limited recourse”. Lenders seek additional security to include in the security package, either a full or partial guarantee, or some type of additional claim on existing assets of sponsor companies in the event that cash flows from the project prove inadequate.
This separate SPV also provides “bankruptcy remoteness” for the project’s assets from existing obligations of sponsors, isolating the SPV from the financial troubles of its shareholders, which is very important to lenders.
This SPV should exist before approaching investors, even if more equity needs to be raised later from other sources, because this SPV is the legal entity that will enter into financing agreements, finalise project contracts, and show proper corporate governance structure that gives investors confidence.
Clearing the FOG of your project structure
Over time, I have learned to use Clear the FOG to remember that the clarity in project structure is required across three interconnected dimensions:
Financing, Operating, and Governance – FOG.
Clearing the FOG to me means clearly articulating
Financing Structure: A clear outline of the types of capital that will be provided to the project SPV, either as—Equity, Mezzanine debt or Senior Debt. A clear financing structure demonstrates a carefully crafted capital stack with clear seniority of prioritisation of repayments, which will be embedded in the financing agreements and Equity agreements (Joint Development, Joint Venture, Shareholder agreements)
Important pre-work before approaching investors includes research, thinking through, and preparing to answer questions like
Do we have up to 20 - 30% of project costs for equity, or will we need more equity partners? Know that demonstrating the capacity to provide significant equity contributions is a tangible sign of project robustness.
Is there a valuation of the project that allows us to determine how to allocate equity to new sponsors on the SPV?
Which entities provide subordinated/mezzanine debt that can take more risk and provide a cushion of loss (first loss capital) that may give comfort to longer-term senior debt lenders?
Who or which agencies can provide concessionary interest to blend down the cost of capital?
What are the prevailing interest/lending rates in the market today?
What type of recourse, security, or collateral can we provide for debt if we cannot pledge our current balance sheet? Guarantees? Insurance? Completion bonds? Etc?
What financing structure emerges that has the optimal cost of capital?
What are the project’s returns and economics after testing out different capital structures and costs of capital?
Depending on the scale of your project, if your CFO has limited experience raising capital, then a financial adviser can be a worthwhile investment to obtain support with this exercise.
Do not wing it; these are questions you will need to anticipate anyway when raising capital, as they will be covered during investor due diligence, credit assessments, and negotiation of terms.
Operating Structure: This defines key parties responsible for the project's execution and performance: the builders (EPC), the operators (O&M), the suppliers of inputs, and the off-takers (end-users or buyers) of outputs. The strength of the operating structure lies in the seamless integration and enforceability of the commercial contracts that bind these parties together with the SPV, ensuring clear responsibilities, risk allocation, and capacity to fulfill performance objectives.
Know also that if any of the project sponsors in the SPV are functioning in any of the roles in the operating structure, there must be separate agreements between that sponsor and the SPV, because they are a separate legal entity from the project SPV. In this situation, the agreement must properly balance conflicts of interest between the success of the sponsor's business and the success of the project SPV.
If you executed the mid-stage properly, these project contracts will already exist before approaching investors and should already be in what is considered final form, even if not signed off.
However, if the project SPV is not yet a counterpart to the major project contracts, then arrange to novate or assign, or transfer (as is required) these agreements to the SPV, so they are in the name of the entity assuming the financing obligations.
Governance Structure: This pertains to the executive oversight and administrative controls within the Project SPV. A well-defined governance structure is often interlinked with the financing structure, with a big part of it formalized within the shareholder agreement and the financing agreements. The Governance structure establishes decision-making authority, accountability, and mechanisms for managing the project, project cashflows and resolving conflicts of interest.
Capital Stacking in the Financing Structure: Prioritizing Obligations
The financing structure of a project involves "capital stacking," which refers to the composition of funding raised for the project, dividing the financing into various types of capital, each with different risk-reward profiles and seniority of obligations and payments in the event of financial distress.
No project is 100% debt-financed. There must be equity. The typical mix for infrastructure projects often on average of 70% debt and 30% equity, though if flows are really strong, and credit risk is deemed comparably low, sometimes 80% Debt and 20% equity. The type of capital typically falls into:
Senior Secured Debt: This forms the largest portion of the capital stack and has the first claim on the project's net operating cash flow. It is typically provided by commercial banks, insurance companies, pension funds, and raised as bonds in capital markets or direct financing from one or a few lenders. These seat at the top of the stack and have the lowest risk appetite, typically lower interest rates compared to mezzanine. They will want to be paid first in the seniority of obligations.
Mezzanine Debt: Mezzanine originates from an Italian word meaning middle or intermediate. It denotes the types of capital that are midway between senior debt and pure equity. Subordinated or below senior debt, but above pure equity in seniority of obligations. Mezzanine financing can serve as a form of credit enhancement or stand-by capital from sponsors like shareholder loans from equity holders, or they can be subordinated debt from investment /infrastructure funds.
Equity: This represents the funds contributed by the project's shareholders, including sponsors, financial investors (private equity), and sometimes other directly interested parties like end-users, suppliers, operators, contractors, or government agencies. Equity holders are the owners, bear the highest risk, and consequently expect the highest return on their investment. The timing and amount of equity contributions are crucial, as lenders view a significant equity contribution as a sign of strong sponsor commitment. Sponsors generally prefer to postpone equity payments, while lenders prefer early contributions to reduce risk.
The volume from each type of capital and the corresponding interest rate or targeted return drives the weighted cost of capital of the project, which then drives the amount of extra cash that needs to be generated in addition to operating costs, in order to pay back lenders plus provide dividend payouts to equity holders.
The ability to obtain funding at the lowest possible blended cost over the project's life is a key objective for sponsors and financial advisors. This involves careful consideration of interest rates, fees, and the overall debt service profile. – You need to be ready to discuss this with investors.
How the Capital Stack Can Influence the Governance Structure
The composition of the capital stack profoundly influences the governance structure of a project, largely through the stringent requirements and controls imposed by lenders. Given that project finance is typically a highly leveraged transaction, lenders will control the destiny of the project; their satisfaction is paramount.
You need to be ready to engage and discuss the following with investors:
Covenants: Lenders protect their interests by imposing a comprehensive set of restrictions on the Special Purpose Vehicle (SPV). These covenants are designed to ensure that the project is constructed and operated as contemplated in the technical and economic assumptions, provide early warnings of potential problems (political, financial, contractual, or technical), and protect the lenders' liens. They include requirements for maintaining an adequate supply of fuel, adherence to operating budgets, and restrictions on modifying project agreements.
Reporting requirements are also extensive, allowing lenders to continually monitor the project's development and performance against underlying economic assumptions, enabling early intervention if problems arise.
The cashflow waterfall: This establishes a strict order of priority for how the SPV's cash flows are distributed. First priority typically goes to operating costs and taxes, followed by debt service (principal and interest payments to senior lenders). Only residual funds, - after these obligations and any required reserve accounts like Debt Service Reserve Accounts or O&M reserve accounts are covered - can be distributed to sponsors as dividends. This structure ensures that lenders' claims are prioritized, reinforcing their control over the project's financial destiny. Lenders may also impose "cash sweep" mechanisms, where surplus cash beyond an agreed distribution level is used to prepay debt, especially in projects with irregular cash flows.
The content of shareholders' or joint venture agreements: These inform the relationship among the equity investors and, by extension, the project governance structure. These agreements cover critical issues such as management and control, board positions, voting rights, equity contributions, dispute resolution, and resolution of potential conflicts of interest, particularly when a host government is involved. Lenders exert influence by requiring these agreements to be carefully structured and by having direct beneficiary rights to shareholder promises of equity funding. Furthermore, equity acceleration clauses might allow lenders to demand the full payment of SPV equity immediately if the project is in technical default.
SPV Startup team: The SPV itself, at the time of approaching investors, will have minimal corporate structure, likely not yet having its own formal organization and management structure, with sponsors' staff handling development work up to this point. However, lenders may insist that key management personnel for oversight of construction, setup of operations, need to be in place early, to ensure appropriate design and satisfy lenders before funds are advanced.
Bringing it all home
If you have come this far on your project development journey, well done, you are almost ready to engage with investors. Just before you approach investors, know that in addition to project documentation, studies, and financial model, your project will need a clear and suitable financing, operating, and governance structure, all linked to a new and separate project SPV, if you are raising project finance.
Know also that the clarity of the project structure is something you begin on your own, by properly negotiating project contracts that underpin the operating structure, creating a project SPV to ring fence assets and liabilities on a new balance sheet, then preparing to adequately negotiate with investors to conclude the financing and governance structures which are linked to debt and equity investments into the project.
Reviewed to complete this note:
Project Finance for Infrastructure in Africa by Arnaud Dornel
Project finance for Business Development - John Triantis
Principles of Project Finance – E.R Yescombe
Innovative Funding and Financing for Infrastructure Addressing Scarcity of Public Resources - Jeff Delmon
Project Finance in Theory and Practice - Stefano Gatti
Project Finance in Theory and Practice Designing, Structuring, and Financing Private and Public Projects, 4th Edition - Stefano Gatti
Financing Energy Projects in Developing Countries – Hossein Razavi
Project Financing Asset-Based Financial Engineering - John D. Finnerty
Capital Structure and Market value of firms in an Economy – Ikye Okoro
Project Financing 8th Edition - Frank Fabozzi, Carmel de Nahlik
Introduction to Project Finance in Renewable Energy Infrastructure, Including Public-Private Investments and Non-Mature Markets - Farid Mohamadi
Principles of Project and Infrastructure Finance - Willie Tan
Structured Finance LBOs, Project Finance, Asset Finance and Securitization - Charles-Henri Larreur
Policy, Management and Finance for Public-Private Partnerships; Innovation in the Built Environment - Akintola Akintoye, Matthias Beck
International Project Finance in a Nutshell - John Niehuss
The Law and Business of International Project Finance, Second Edition - Scott L. L. Hoffman
International Best Practices of Public-Private Partnership: Insights from Developed and Developing Economies - Robert Osei-Kyei, Albert P. C. Chan