Project Equity — what does it mean?
In project finance, “equity” refers to all forms of capital except Senior Debt. This can seem confusing at first glance, but think about it. There is a requirement for owners to commit a certain amount of capital either from their own sources or through third-party investment to secure senior debt. That is considered “owner equity.”
We often get asked why lenders or some equity investors expect others to put in so much money? There’s safety in numbers.
Generally, using as much Senior Debt as possible leverages and improves returns for equity owners. So, how much debt is possible or even optimal when interest rates are higher than normal? If you can get a low interest rate without a prepayment penalty, and can qualify (low enough credit risk, and usually at least 15-35% equity from another party at the time of funding, included in the “capital stack”), then that can help preserve ownership interest.
Some funders (such as private In3CAP) can provide all equity without the need for control or
Equity means two things, in this context — both “ownership” (shareholding) and it also refers to the amount of capital contributed by the owners other than senior debt, including subordinated debt, grants, and of course cash from shareholders.
To make matters even more confusing, all of the capital used to finance projects is most often considered a type of “alternative” investing. A variety of investor types will provide capital into projects they like, including some VCs, Private Equity firms (what’s the difference?), quite a few family office investors, and even some High Net Worth Individuals (HNWIs).
Either way, an equity component in a project finance transaction is inevitable. Very few investors will offer 100% debt, and when they do, even if they don’t call it “equity”, they will also ask for rights to cashflows. That is the original meaning of “equity” in both venture and project finance terminology — it means “ownership”, in essence.
In3 Capital Partners — an innovative approach
Project capital can either come directly from In3’s “in-house” Capital Partners (see Capital Guarantee Program™) or, without a loan guarantee during construction and/or for project budgets under $25 million, can instead be arranged through In3 advisory services. The traditional capital stack is usually comprised of some or all of the following equity asset classes:
- traditional equity: cash paid in exchange for an ownership stake, usually in the form of shares or units.
- quasi-equity (has some traits of equity, such as having flexible repayment options or being unsecured): includes convertible equity (two classes of shares that convert upon reaching a milestone), subordinated debt, mezzanine or convertible debt (see debt)
- redeemable equity: see below example in Real Estate, mainly used in that asset class context.
- in-kind contributions (but with limits on intangible asset contributions … namely, labor — “sweat equity” does not count as a capital contribution per accounting rules).
In3 Capital Partners do not use a traditional capital stack at all — 100% financing with a minority equity stake as “hybrid” financing without using senior debt (pledge of assets as collateral via perfecting a lien). Instead, we use a capital guarantee to ensure that the project’s assets actually get built and begin commercial operation; more on capital guarantees.
The terms of an equity investment are usually negotiated with the investor, but generally include rights to cashflows or dividends paid from retained earnings (net profits). Our in-house investor offers rapid closings, flexibility with the risk profile (projects need not be entirely shovel-ready, and lower total capital costs. The equity component, in the form of a dividend proportionate to their shares of ownership, is for the life of the assets.
By contrast, to help illustrate equity ownership dynamics, consider the example of redeemable preferred shares, often used in real estate and some infrastructure investments: the equity investor’s exit is taken gradually, often over a few years, decreasing ownership stake year-by-year, but retaining dividends until they no longer own any shares.
Which sources are best and in what combination? Optimal funding strategies, including the right forms and amounts of debt, or as convertible equity, are key to a success. In3 can help you figure out the optimal combination of equity and debt, including options attuned to your situation, goals and strengths.