Principles of Project Finance

structures may just add to the time and cost of putting the deal together, or be too

rigid if something goes wrong, or add extra risks that cannot be foreseen at the be-

ginning. The financial structure should therefore be kept as simple as possible; for

example, several different sources of debt should not be used if sufficient finance

can be raised from one source, as it is far quicker and easier to deal with one group

of lenders (e.g. avoiding intercreditor problems). As far as possible, financing

should also be kept sufficiently flexible to accommodate changes in the project

over time.

It is also easy for both Sponsors and lenders to get so carried away by the detail

of structuring and negotiating the deal that the big picture of what really matters gets

buried. For example, lenders often fall into the trap of imposing unnecessary con-

trols over the Project Company’s activities, or an overelaborate system of informa-

tion flow about the project, which both hinder the Project Company from doing its

job of running the project efficiently, and burden the lenders with information they

do not read or with the task of taking decisions that are a waste of their time.

§13.1 DEBT:EQUITY RATIO

As already discussed, a high ratio of debt is the essence of project finance.

Within prudent limits, therefore, Sponsors wish to limit the amount of equity they

invest in a project, to improve their own return, and thus to raise the maximum

level of debt.

Once the maximum level of debt a project can raise has been determined, the

difference between this figure and project costs in principle determines the amount

of equity acquired (although some of the gap may be filled with mezzanine debt

(cf. §3.3) or public-sector grants.

§13.1.1 L

EVEL OF

D

EBT

Two factors determine the level of debt that can be raised for a project:

Lender’s cash flow cover requirements. There is obviously a fundamental

difference between a project with a Project Agreement that provides reason-

able certainty of revenues and hence cash flow cover for debt service and a

project such as a merchant power plant selling into a competitive and com-

paratively unpredictable market with no form of hedging of the revenue

risks; it is evident that the latter type of project cannot raise the same level of

debt as the former.

Similarly, a project in a high-risk country cannot raise as much debt as the

same project in a low-risk country, because the lenders will consider the cash

flow less certain, even if it is contracted through a Project Agreement.

284 Chapter 13 Financial Structuring and Documentation