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PPP Introduction and Overview

17.1. Private Finance and Project Finance[73]

As a private-financed procurement method, all (or most) of the resources for financing the capital investment comes from the private sector.

The PPP structure assigns to a private agent, through a contract, the development and business operation or exploitation of a public asset (under certain rules and conditions). The private partner will commonly create an SPV, usually in the form of a limited liability company. The specific purpose of the SPV is to develop and then operate the specific infrastructure business, using the infrastructure asset.

The private partner is responsible for providing the funds to develop the business (that is, for design and construction through to completion of the asset), except to the extent that the government is acting as co-lender or equity partner or, more commonly, provides part of the funds if the PPP is a co-financed project (in the form of public grant financing).

As in any capital intensive business, the sponsor will use debt to leverage the investment. This is due to the scale of the investment and the cost-efficiency of debt when available at proper rates and conditions.

Normally, the debt finance is provided using the “project finance” technique. Project finance is a non-recourse financing technique in which project lenders can be paid only from the SPV’s revenues without recourse to the equity investors[74]. The project´s company obligations are ring-fenced from those of the equity investors, and debt is secured on the cash flows of the project. The financing will be a combination of equity (provided by the shareholders of the project company, which are in turn the members of the successful bidding consortium) and debt (provided by lenders such as commercial banks or other lending agents[75]). Equity will always bear project losses ahead of debt, as payments to equity are always subordinated to the service of debt. Debt service is fixed in a debt program with a contractual payment schedule comprising principal and interest. Therefore, equity requires a higher price (return) than debt (see cash flow cascade in appendix A).

As a technique based on the reliability of future cash flows, the requirement by lenders of a material equity investment is a paramount condition to access to the debt facility, in addition to standard covenants related to minimum cover ratios (Loan Life Cover Ratio – LLCR[76] and especially Debt Service Covered Ratio – DSCR[77]).

The typical financial structure has a debt to equity ratio of between 60:40 and 80:20, with some projects having more (or less) aggressive financial structures as explained below.

Debt generally requires lower returns than equity in the form of interest. So from a public sector/government perspective, leverage is positive since the mix of financial costs (the WACC[78]) is lower. Therefore, the payments required from the government to make the project commercially feasible are lower. Or, in user-pays PPPs, the likelihood of the project being self-sustainable is higher.

Project finance provides some important benefits.

  • The authority will benefit from the lender’s oversight of the project governance and performance, which is inherent in the technique. Cash flow reliability is at the heart of project finance as project cash flows are the sole basis to recover the loan. Lenders will therefore add an additional layer of due diligence to the government appraisal and the bidders’ own due diligence of the project; and
  • Project finance allows the sponsors to raise third party funds without being directly liable to the lenders. Therefore, this frees higher equity capacity to invest in more projects while maintaining a healthy financial structure at the corporate/holding level.

For these reasons, governments need to pay attention to bankability when appraising and structuring the PPP project. Bankability is an intrinsic element of commercial feasibility (commercial feasibility tests, including bankability assessment, are a part of the appraisal exercise and, as such, are discussed in chapter 4).

Bankability of a project may be defined as the level of willingness of prospective lenders to finance the project, that is, what amount and under what conditions. Higher bankability means access to more funding and/or better conditions in terms of the amount of debt (leverage), the loan term, and the loan costs. Debt amounts and therefore gearing will depend on the projected cash available each year for debt service (therefore on the amount of revenue projected and reviewed by lenders and/or its advisors under a due diligence process) and its reliability. If prospective lenders consider the project to have an unacceptable level of risk and uncertainty, they will not provide finance and the project will not be bankable[79]. For a wider explanation of lender´s concerns when assessing a project see box 1.23.

BOX 1.23: Major Concerns of Project Lenders

  • Certainty about the project cash flows needed to meet debt service requirements;
  • Sufficiency of the project cash flows for making the expected (or a reasonable) profit for the equity investor;
  • Creditworthiness of the public sector (in terms of meeting its obligations);
  • Soundness and stability of the legal framework for PPPs;
  • Effectiveness and enforceability of the PPP contract and related agreements;
  • Confidence in the regulatory regime;
  • Right to step in if a project fails, and availability of alternative contractors;
  • Ability of contractors to perform and the quality of their management;
  • Creditworthiness of the contractors and the quality of their guarantees;
  • Risks must be understandable, controllable, finite, and appropriately allocated;
  • Acceptability of the termination regime (providing sufficient protection to the debt);
  • Reputation impact of the project (environmental and social) [80]; and
  • Availability and effectiveness of insurance coverage.

Source: Adapted from World Bank - Farquharson, Torres de Mästle, and Yescombe, with Encinas (2011).


Higher debt levels or higher leverage will be possible (from a lending perspective) as long as the predictability and stability of the cash flows is higher and the risks are lower. In that sense, government-pays PPPs, especially those based on availability payments, will usually benefit from higher level of debts/leveraging which are due to the lower covenants required in terms of DSCR (see figure 1.12).

FIGURE 1.12: The Debt Service Cover Ratio

Note: DSCR= Debt Service Covered Ratio; O&M= operation and maintenance.

However, excessive leverage may endanger the sustainability and solidness of the PPP project, increasing the probability that the SPV becomes insolvent and potentially bankrupt. For that reason, PPP contracts usually require a minimum level of equity or a set maximum degree of leverage (see section 7.3).

The financial package for a PPP will therefore be a combination of equity and debt with high levels of leverage. Some projects in developed countries can show very high leverage (up to or around 90 percent) or lower levels (60 percent), depending on the risk profile of the project. Generally projects with significant demand risk and hence less predictable cash flows will show lower leverage, whereas availability payment PPPs with low risks and hence very stable cash flows will show high levels of leverage. This range slips to 50–80 percent in EMDE markets.

The next section explains the different forms of debt and briefly introduces financial structuring strategies used by the private sector to increase efficiency. It also explains sources of funds and different instruments for the equity investment.

BOX 1.24: Key Considerations Regarding the Financial Structure of the PPP Project<br />
• A typical financial structure is based on non-recourse/limited recourse project finance techniques, limiting the risk exposure of the investor/promoter of the project, and adding some due diligence and control by lenders.<br />
• The SPV will finance the project (the asset) by a mix of debt and equity.<br />
• PPP project companies (SPVs) usually enjoy higher levels of gearing than other companies. This is due to the higher predictability of their revenues and the other business protections inherent in the PPP business.<br />
• A higher level of debt provides higher efficiency in terms of the cost of capital. This increases the capacity of promoters to expand their businesses and invest in more projects (within a limit).<br />
• Bankability is one of the cornerstone issues of feasibility within the PPP procurement context. The contract structure needs to protect bankability, otherwise Value for Money will be lost. However, excessive levels of debt might endanger the long-term sustainability of a project contract, unless the project cash flows are very stable. </p>


[74] “Non-recourse” means the inability of the lender to claim against the shareholder of the company in case of default. However, pure non-recourse debt in the field of PPPs is generally not achieved, especially in less sophisticated markets. These are situations where the promoter/contractor is usually the most relevant if not the only equity holder, and where lenders usually establish recourse against the equity-holders (at least during construction period). For this reason, some practitioners also refer to the tool as “limited-recourse” financing.

[75] The most common form of project finance is a long-term project loan. However, financing may also be provided in the form of a project bond structure, or the loan may be a mini-term structure. This is explained in section 7.2.1 “sources of funds”.

[76] LLCR assesses the ability of the project company to meet its (remaining) debt obligations by considering all the projected remaining cash flow before debt service (in Net Present Value, NPV, terms) compared to the outstanding debt of the particular year of the analysis. 

[77] The DSCR assesses the ability of the project company to meet the debt service payment for each year, by dividing the projected operating cash flow, before debt service, by the debt service of the respective year. For example a ratio of 1.2 means that the available cash flow is 1.2 times the debt service of that particular year. This means that there is a cushion of 20 percent in net operating revenues, that is, these could be reduced by up to a 20 percent without affecting the ability of the company to pay the debt.

[78] The WACC is the average cost of all the private financing resources of the project. It is a weighted average of the cost of the equity resources and the cost of debt.

[79] The issue of project finance and loans based on project risks has other consequences in the future contract beyond risk structure and financial feasibility: caring about “lender´s rights” so as to be able to step into the project is explained later in this section.

[80] Many commercial lenders and all MDBs will assess the compliance of the project with the Equator Principles. See

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