Equity finance is usually provided for the full project term, through a combination of ordinary shares in the private party, and subordinated debt provided by sponsors and sometimes external investors.
The involvement of equity finance in a project's financing mix creates significant incentive for the private party to deliver high performance, particularly where a material proportion of the equity is comprised of 'active equity' (equity contributed by one or more of the key private party entities that is in a position to influence the private party's performance).
Equity investors receive a return on their investment over the life of the PPP project. In many PPP projects, much of the equity investors' return is only received in the later years of the project. This provides a strong performance incentive - equity investors will be motivated to ensure that the project performs so that they receive these strong returns in the later years.
Equity finance serves an important purpose in providing the private party with adequate capital to absorb negative financial consequences arising from risks materialising. Many risks will have been transferred to subcontractors, however if that risk transfer is ineffective (for example, because a subcontractor becomes insolvent or because the risk transfer is poorly documented) the financial consequences will flow through to the equity investors. Some other risks are generally retained by equity, and are not transferred to subcontractors.
In addition, equity's involvement reduces the risk shouldered by the debt providers, as the equity providers in the consortium are in a first loss position. As a result, the providers of equity finance risk losing some or all of their investment if the project does not go well. However, they also expect to earn a higher return on their investment than the providers of senior debt finance, if the project is successful.
In some projects, finance may also be provided in the form of mezzanine debt (ranking in priority between senior debt and equity) or through a hybrid financial instrument (which can have some characteristics of equity and some characteristics of debt, depending on the specific terms agreed with the financiers). As such, the government party should ensure that it understands the nature of such instruments and how they are treated in the project deed and related contractual documentation (whether it is treated as debt or equity).