This sub-section describes the parties that provide finance to the project. The parties are classified according to what types of interest they hold in a project company. The sources of finance for the project are described in section 4.3.
A sponsor holds equity interests in the project company while a lender provides debt finance to the project company. A bondholder holds security in the company that is neither purely equity nor debt, but somewhere in between.
Traditionally, equity is distinguished from debt in the following important ways:
• Control. Equity holders (ie shareholders) are regarded as "insiders" of a company. A majority of shareholders have control of the project company. Shareholders influence the direction of the project company indirectly through the right to appoint and remove the board of directors, and directly by the exercise of voting rights in a shareholders' meeting. Shareholders also have voting rights in relation to decisions made by the company. The control of lenders, by contrast, is limited to those expressly provided in the loan agreements, for example loan agreements usually limit the project company's ability to pay dividends or take out another loan. The residual rights and responsibilities in relation to management and control of the project company, however, remain with the shareholders.
• Profits. A company is required to pay the interest and principal it owes to the lenders in accordance with the loan agreements, irrespective of whether the company is making a profit. By contrast, company laws of most jurisdictions prevent the company from declaring and paying profits unless it is earned or accumulated. On the other hand, the shareholders have unlimited "upside" potential. That is, while lenders are only entitled to a specific rate of interest, shareholders' potential gain if the company increases in value or declares a profit is not subject to a maximum cap.
• Priority on winding up. On liquidation of the company, lenders will be ranked first in terms of priority. If there is insufficient money to pay all its creditors, the shareholders will not receive a return of their capital investment.
(a) Sponsor
A sponsor subscribes for shares or equity in the project company, and may provide other forms of finance by way of a subordinated debt.
Project sponsors may be one company (subject to local laws about the minimum number of shareholders for a company) or a consortium of interested parties, such as contractors, operators or suppliers of the project. Depending on the structure of the project, a sponsor may also be a user of the product, where the obligation to purchase products from the project company is based on a take-or-pay agreement. The sponsors may also be investors whose interests in the project company is purely financial, and they are looking for a return on their equity investment.
A sponsor's interest in the project company (and hence the project) may take several forms depending on the structure of the project. The most common interests of equity holders in a project company, and agreements that underlie these different forms of interests in a project company are as follows:
• Shares. The company laws of the place of jurisdiction of the project company would set out the rights and obligations of the sponsors as shareholders of the project company. These rights and obligations may be modified (to some extent) or appended in the formal organisational document of the company (for example, articles of association, by-laws, constitution) or a contract (for example shareholders' agreement, joint venture agreement, equity subscription agreement). Whether they are contained in the formal organisational document or a contract would depend on the particular laws of the country as well as the objectives of the sponsors in relation to, for example, confidentiality and flexibility. The issues dealt with whatever the form of the documentation would be similar. For convenience, we will refer to the document governing the rights and obligations of the sponsors as the shareholders' agreements, even though the issues may be dealt with in other documents of a project company (such as the articles of association or the constitution).
• Subordinated debt. The sponsors may also advance monies to the project company as a subordinated debt under a subordinated loan agreement. Actually this usually occurs if the sponsors are already shareholders in the company, and also usually in the proportion of the shareholding.
• Options. In addition, a sponsor may advance monies to a project company as a debt that is convertible to shares at certain exercise events (options). Depending on the corporations law of the local jurisdiction, the project company may issue a range of securities that are options or other securities. These are distinguished from the issue of quasi-equity securities in chapter 5.5 of this guideline because it is an issue of securities to private shareholders rather than to the public. For the purpose of this guideline, the private agreements creating or underlying such securities will be referred to as an options agreement.
(b) Lender
A lender contributes to a project to debt finance. Usually, the debt finance is provided as a loan with a specified rate of return on the capital. The primary concern of a lender is to earn a margin between the interest rate it receives on the loan and the interest it pays on deposits. The corollary concerns are that the project company (as the borrower) is able to repay the principal and interest due for the loan, and that the lender would have remedies against the project company and the guarantors (if any) if the project company fails to repay the loan. A lender will therefore look at the creditworthiness of the project company and any guarantor, the risks associated with the project and the security for the loan.
The interest rates paid to the lenders reflect a lender's exposure to risk. As a general rule, a project finance involves greater exposure to risk than ordinary loans secured by assets in the balance sheets, and therefore interest rates tend to be higher (reflecting the requirement of higher margin for higher risks). A lender will conduct due diligence on the project to ensure that the project company is in a position to repay the capital and the interest, whether through cash flows generated by the project or through government or other subsidies. A lender is also concerned about its security, that is, the ability to recover its capital and interest costs if the project company fails to repay the capital and interest.
Typically, a security package for a project would include the assignment of the project agreements (in particular, the concession agreement and the off-take agreement) as well as any assets owned by the project company. In particular, a lender would look for agreements that entitle the project company to cash flow, such as customer agreement or off-take agreement. Where the project company's revenues arise from the general public, an escrow agent may be appointed to hold on to these revenues as additional security.
Debt funding is "cheaper" than equity funding from sponsors. Consequently a company that obtains debt finance is said to be obtaining "leverage" which would result in higher rates of return for the equity investors. Higher leverage, however, implies higher risk, because the project needs to generate sufficient income to cover interest costs, compared with profits which need not be distributed if the project fails to generate sufficient income.
Sources of debt finance are banks, multilateral institutions, institutional investors and the government.
(c) Security holder
The project company may issue securities to raise finance for an infrastructure project. A security holder would purchase the securities, such as bonds, that usually provide for a return at a specified interest rate. A trustee will enter into a trust deed on behalf of the security holders and agree on the terms and conditions of the securities. These types of securities are regarded as "quasi- equity" securities. Absent of terms in agreements and conditions of the securities to the contrary, on liquidation quasi-equity will generally rank behind the lenders but before the equity holders.
In most jurisdictions, bonds would represent securities in a project company. Depending on the local laws and regulations, there may be a lot of flexibility about the terms of the securities. For example, there may be an in-built option allowing the securities to be converted to shares in a company at a particular price (rather than repaid as cash). A security holder would exercise this option if the market price at the time of the repayment is higher than the price specified in the option.
Sources of security finance are institutional investors, banks and multilateral institutions.