In our previous article about project financing, we discussed the key steps for successfully financing sustainable energy projects, including solar, wind, geothermal energy, and recycling. We highlighted how project financing works and the crucial role of solid contracts, subsidies, and permit requirements in providing security for investors. We referenced 5 crucial characteristics that are often overlooked. Here they are:
Special purpose vehicle (SPV)
For a project financing, a separate project company (SPV) is often established. This allows the debt and income of the project to be placed in a separate legal entity, separate from the assets of the SPV’s shareholders. Leading up to a project, agreements are often already entered into or the SDE subsidy is applied for, while the SPV has not yet been established.
The project financier requires that all relevant agreements and the SDE subsidy be in the name of the SPV. It is advisable to establish the SPV as soon as possible. If not, it is important to prepare in advance for the possibility of an unconditional transfer of the relevant documentation to the SPV.
Allocation of risk and liability
In every agreement there is an allocation of risk and liability between the parties involved. For the SPV, it is important to limit those risks and possible liability as much as possible, or fix them at fixed prices. A project financier will attack agreements that may lead to ongoing price increases or decreases. This is because these have an impact on the expected future cash flows on which the project financier provides the financing.
Maturity
Project financing often has a term that is slightly longer than the term for which the SDE subsidy is provided. This is because much of the cash flow used to repay the project financing comes from the proceeds of the SDE subsidy. For example, the SDE subsidy is a payment for the kilowatt hours generated, which of course must also be purchased. It is desirable that the off-take contracts have at least the same duration as the duration of the project financing. Where this is not possible, it should be possible to demonstrate that there is sufficient demand from other customers with whom new off-take contracts can be concluded on equal terms.
Price adjustments or indexation.
The ability of contracting parties to adjust prices from time to time during the term of an agreement should be limited as much as possible, as this will affect the SPV’s business model. Given the long duration of a project financing, some form of price indexation in the project documentation is common. Pay attention to the standard chosen for indexation and the frequency. Annual indexing can have a significant impact on prices during a 15-year agreement. The SPV should ensure that such increases are sealed “back to back” as much as possible so that price adjustments can be passed on equally and the bottom line for the SPV is zero.
Choice of law and forum
The project documentation must be governed by Dutch law. The choice of forum (choice of, for example, the “ordinary” Dutch court or arbitration) in project documentation often depends on the relevant agreement. For example, construction contracts generally choose arbitration before the Board of Arbitration in construction disputes. It is important to thoroughly consider with each agreement what is an appropriate choice of forum. Consider also the duration of the resolution of a dispute at that forum and what the costs are associated with proceeding at that forum.
The main differences between a project financing and a regular corporate financing:
- Repayment:
The repayment of a project financing is based on future expected cash flows from the project, while the repayment of a corporate financing is through general income of the company, based on past performance. - Liability:
In a project financing, liability is limited to the project and the project company; in a corporate financing, liability extends to the entire company and its subsidiaries. - Use Special Purpose Vehicle (SPV):
For a project financing, an SPV is established to bring debt and income of the project into a separate legal entity, separate from the assets of the SPV shareholders.
The corporate financing is provided to an existing company within the company. - Structure:
The structure of a project financing is complex due to the required seamless relationship between construction contracts, supplier agreements and off-take contracts.
With a corporate financing, the structure is in principle simple, it is based on creditworthiness based on past performance. - Capital requirements:
The capital requirements in a project financing depend on the risks of the project. Own contribution from the sponsors is required in any case, the more risky the project is, the more own contribution will be required by the financiers.
For corporate financing, own contribution is in principle not necessary. - Maturity:
The term of a project financing is long, usually linked to term SDE subsidy, while the term of a corporate financing with a term of basically five years is short.
