8. Equity Funding Options for Business or Project Finance
Under a business or project finance structure equity in some form will be required to launch a water enhancement development. It will be necessary to secure a source of equity financing before any debt providers will consider advancing funds.
Outlined below are the various sources of equity funding available under these structures.
8.1 Private equity
8.1.1 Water Users
Water users are the direct beneficiaries of the scheme and with a significant on-farm investment at risk, is the group most likely to want to own and control the scheme assets.
One of the key advantages of equity investment by water users is that it demonstrates long-term commitment to the scheme from the customer base. As a result, the scheme is more likely to receive support from other private sector investors and/or Government if required.
However, accessing large volumes of equity from water users is likely to be difficult given that water users may not be able to access the required level of funds and still have funds available to complete on-farm development.
8.1.2 Private Investment
Generally private investors are driven by the investment rate of return. The rate required is derived from the risks associated with the investment.
Typically a return of 10 percent – 15 percent after tax is required for these types of projects.
There are various ways that a private investor can achieve the level of return outlined above from a water enhancement investment. These include:
- Dividend payments made from scheme operating profits.
- Capital growth in the value of shares based on expectations of financial return.
- Capital profit generated from issuing of new shares at a premium based on additional scheme capacity or further scheme development.
- Speculation in the trading or leasing of water rights. This is a higher risk investment and therefore the expected return would need to match this profile.
8.1.3 Equity Structuring for Private Investment
Private investors have different investment requirements and objectives to water-user and therefore a scheme needs to be structured appropriately if it is to be funded using a combination of these investors.
A water user is primarily motivated to invest in a scheme to get access to water rights and to pay the lowest possible charge per unit for water use.
A private investor does not want access to water rights (given the take-or-pay commitment attached) but wants to charge water users at a rate that will provide an adequate return on the funds invested.
In order to meet the objectives of both investors the most effective way is to set up separate classes of shares.
For example:
- Class A shares:
- no water rights attached;
- preferenced for dividend payments, or cumulative dividend rights attached.
- Class B shares:
- water rights attached;
- take-or-pay commitment attached;
- subordinated for dividend payments (if any).
8.2 Government (Public) equity
Government (Central and local) investment criteria and prioritisation in relation to equity investment has been outlined in Study 3 – Role of Central Government and Study 4 – Role of Local Government.
8.2.1 Standard Equity
Government investment requirements are similar to those of the private sector discussed above. A scheme must therefore be structured in a similar way to meet investor return and exit requirements:
- Government equity and rights to take water must be separated in-order to exclude Government from take-or-pay financial commitments. This can be achieved through the issuing of separate share classes.
- There must be an ability to exit the investment, therefore a mechanism for trading shares must be available.
As with debt, Government equity provides credibility to the investment and comfort to other private debt and equity investors as it is seen as a corner stone shareholder for the development.
Government may be prepared to accept higher investment risk with lower financial return expectations given that a portion of the return will be provided through economic and social benefits to the region.
8.2.2 Hybrid Equity
Hybrid Equity is a form of permanent capital with certain characteristics both of debt and equity. Hybrid equity can be viewed as equity for financing purposes, because it ranks behind senior creditors and debt, but does not generally share in the equity upside, e.g. share price appreciation, as a fixed rate of return is paid.
Possible forms of hybrid equity applicable to irrigation developments include:
- Subordinated loans;
- Redeemable preference shares;
- Convertible notes.
Hybrid equity allows Government to provide equity support to a water enhancement scheme assisting with gearing requirements, but also provides Government with the advantages of lower risk debt funding including a fixed rate of return and a clear exit strategy through repayment of the debt or a take-out of the debt by the private sector.
Hybrid equity allows Government the greatest flexibility to structure the financial support to meet the needs of both the scheme and Government.
8.2.3 Effectiveness of Government Debt Vs Equity
It is difficult to give a generic recommendation as to which is the most effective form of Government investment as this is determined by the specific circumstances of individual schemes.
For example:
- A scheme situated in a region with high water user commitment but limited capacity to provide equity for the scheme would benefit mostly from an equity contribution allowing the scheme to leverage the required level of debt funding.
- A scheme in a region where water user access to equity is high but gaining sufficient commitment is an issue, the scheme would benefit more from Government underwriting revenue during the take-up phase.
This has been demonstrated by the range of support provided by Government when funding infrastructure assets in the past. i.e.
- Debt funding – provided to Opuha and Waimakariri,
- Equity contributions – provided to Opuha,
- Hybrid equity – provided to a wood processing facility in Waimate,
- Revenue underwriting – provided to the WestpacTrust stadium in Christchurch.
In most cases the support provided by Government is based on a detailed negotiation process with the individual scheme.
General Recommendation
Provision of Government equity or hybrid equity in most cases is likely to provide the greatest leverage with the private sector and is therefore the most effective investment tool for the scheme. With a Government equity investment, other private sector investments are protected given that equity will rank behind debt in relation to investment returns and access to assets in the event of a company wind up. Other private investors/financiers are further protected under Companies Act legislation with solvency test requirements to be met prior to any distribution allowed to shareholders.
Equity is however a higher risk investment for Government. Applicability of funding options for Government are outlined in Study 3 – Role of Central Government and Study 4 – Role of Local Government.
Contact for Enquiries
MAF Information Services
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PO Box 2526
Wellington, NEW ZEALAND
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