Key points
- Debt is cheaper than equity but needs predictable cash flow
- Contracted revenue supports more debt than merchant revenue
- Development is almost always funded with equity
- The right mix changes over the project life
Renewable energy projects are capital intensive, with most of the cost incurred before the first megawatt hour is sold. How that cost is funded, between equity and debt, shapes the project's returns, the sponsor's control and the investors it can attract.
Equity
Equity is ownership. Equity investors take the first loss if the project underperforms and receive whatever is left after debt has been paid. In return they expect a higher return than lenders and, usually, governance rights in proportion to their stake.
Equity funds what lenders will not: development risk, cost overruns beyond contingencies, and the share of construction cost that debt cannot cover. It is the more expensive form of capital, and raising it means giving up part of the project.
Debt
Debt is borrowed and repaid with interest. Lenders are paid before equity and take less risk, so debt is cheaper. In renewable energy it is usually project finance, sized on the project's forecast cash flows rather than the sponsor's balance sheet, and constrained by cover ratios under conservative cases.
Debt increases equity returns when the project performs, and increases the risk to equity when it does not. Lenders also impose covenants, reserve accounts and restrictions on distributions.
How much debt can a project carry?
That depends mainly on how predictable the revenue is. Projects with long term contracted or subsidised revenue, such as a Contract for Difference or a long term power purchase agreement with a strong counterparty, can typically support a high proportion of debt. Merchant projects, exposed to wholesale prices, support less, with debt sized on a conservative price view. Battery storage, with largely merchant revenue, has historically been financed with more equity, though contracted floors and tolls are changing that. See how to raise capital for a BESS project.
How the mix changes over the project life
- Development: almost entirely equity, from the developer, development investors or strategic partners.
- Construction: equity plus construction debt or project finance, once consent, grid, contracts and revenue are in place.
- Operation: refinancing with longer term or cheaper debt is common once the project has an operating record, sometimes releasing equity for the next project.
Other instruments
Between senior debt and equity sit mezzanine and holdco debt, preferred equity and private credit. They can bridge gaps or reduce dilution, at a cost. Each adds complexity that investors and lenders will want explained clearly.
Making the choice
The choice is a decision for the sponsor and its corporate finance, legal and tax advisers. What investors will test is whether the proposed structure is coherent: that the debt is serviceable under a downside case, that equity returns are realistic, and that each party's position is clear. Capital strategy is where that view is formed before the market sees it.
Before you approach the market. The Investor Readiness Review tells you what an investor will conclude from your materials, and what to fix first. £995 plus VAT.
This article is general information, not investment, legal, tax or financial advice. BriHel Capital introduces only and does not arrange transactions, provide advice, or carry out regulated activities.