Shareholder Support in Project Financings
Introduction
In any project requiring financing, shareholder support constitutes an indispensable pillar. Without shareholder support, the borrower will lack the initial financing to kickstart the project and the creditors will not be in a position to determine the leverage ratio for the funding to be bankable.
Forms of Shareholder Support or Equity Contributions
Shareholder support may be provided in many forms.
A shareholder support or an equity contribution agreement will require the sponsors to commit to contribute a certain amount of equity into the project company as required in the financial model. By doing so, the project company will ensure that the debt-to-equity ratio required by the lenders is respected. This ratio, required usually at a minimum of 20/80, corresponds to the ratio of the total amount of equity provided to the borrower up to a certain date to the total principal amount of debt utilized by the borrower outstanding on the same date, subject to the terms and conditions of the finance documents as required by the lenders. However, the concept of equity does not always correspond to the share capital of the project company.
Indeed, the equity contribution can consist of a shareholder loan, a share capital advance, a share capital increase amount, a convertible loan, an in-kind contribution or an equity cure right and/or a contribution in another form or shape. Equity does not always translate into share capital.
If equity contributions are made in the form of capital, this requires a distribution of dividends or the often more complex process of reducing and repaying the project company's share capital for the contribution to return to the shareholders.
If equity contributions are instead made in the form of shareholder loans, the creditors are likely to request that they become subordinated to the obligations secured by the financing documents. The lenders are also often likely to request that the sponsors’ receivables under such shareholder loans are assigned to them, as part of the security package.
Unlike trapped cash or distributions, subordinated debt has the significant advantage that it can be repaid to the sponsors by the project company whenever distributions of project revenues are permitted subject to the terms of the credit agreement and in accordance with the rules of the payment waterfall. Usually the rule of "first in, last out," applies, acting as a cushion for debt repayment.
Structure of a Shareholder Support or Equity Contribution Agreement
The terms of an equity contribution agreement are usually straightforward. The shareholders that provide the funding (the “sponsors”) are required to provide equity as required and when requested by the project company. This request is made any time it becomes necessary to do so according to the terms of the facility agreement and normally happens when the debt-to-equity ratio required by the terms of the financing is breached due to certain risks that may have been previously identified during preliminary project risk assessment, realize.
The shareholder support at this point constitutes a risk mitigation technique to make the project bankable to the creditors. A risk that is deemed excessive or that cannot be properly assessed and mitigated in any way would make the deal unsuitable for the project finance technique.
In a non-recourse project financing, the principle is that any risk that cannot be mitigated internally, must be dealt with externally. For instance, any increased costs during the construction phase that cannot be mitigated otherwise will naturally be covered by sponsors guarantees. Sponsors can either make the guarantee payment directly to the lenders or inject the same amount of equity into the project company.
Lenders are not required to be parties to the equity contribution agreement. In certain transactions, this has even resulted in the equity contribution agreement being classified as a project agreement rather than a finance document, although—given the nature and purpose of the instrument—the latter classification would ordinarily be more appropriate.
Conclusion
In any event, the equity contribution agreement undoubtedly constitutes an essential component of a project financing structure. The shareholder support enhances the bankability of the project. The commitment of the sponsors to cover the risks foreseen in the project’s financial model, when necessary, strengthens the financial stability of the project company and enables the financing terms to be structured in a more manner. In this respect, shareholder support contributes directly to the effective and secure use of external financing in line with the risk allocation principles of project finance.
Ultimately, equity contribution agreements and shareholder support play a critical role not only at the initial stage of project financing but throughout the entire lifecycle of the project. Therefore, properly structuring these agreements, clearly defining the obligations, and ensuring that they are aligned in a coherent manner with the financing documents constitute fundamental elements that provide long‑term assurance to both sponsors and lenders.
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