There are two essential ways of financing a project finance transaction. One is debt financing and the other is equity financing. Let's take a look at the debt in detail. The main subordinate loans will be typically split into tranches with some being paid off earlier than others and a relevant interest rate adjustment if you get paid later. In other words, you get more interest if you are paid off later, but every loan will be collateralized against all the assets of the special purpose vehicle. Those main loans are known as the base facility. Then you might also have a CapEx facility where you can spend on additional CapEx requirements. An interest facility because you're bound to pay interest during the construction phase, and you'll need to finance that. A working capital facility for things like financing inventory. A VAT facility to pick up the difference between paying VAT during the construction phase and waiting to be able to claim it back during the operational phase. And also a standby facility, which is a just in case facility if you need more money.

Now, there are a few other issues which are relevant and we need to cover them in some detail. The first is the debt service reserve. This is a source of funds which is in place in case the business can't pay interest. And normally that is required to be a certain amount of forward interest, maybe three months forward, six months, nine months, or a year. More commonly though it's six months to a year. So you'll take the forward expected payments of interest in the next six months or the next year, and that's how much cash you'll need to have in the debt service reserve account, just in case the project can't pay that interest from its normal cash generation. The other item, which is more of a ratio than an account, is the debt service coverage ratio, and that is very simple. It's just the amount of cash flow available divided by the repayment and interest on that debt. In most cases, the covenant suites will have a required minimum level of debt service coverage during the projections, and in some cases, the actual debt repayments are calculated around the debt service coverage ratio. So as long as you have a debt service coverage ratio, let's say, of 1.6 times, everything else can be used to repay debt. The benefit of that is it means that cash Is built up into the balance sheet, giving lenders more security. And remember, any cost of this financing is not expensed during the construction period, but only during the operational phase.

So the main other source of financing is equity financing, and this will be provided by the project sponsors. It could be a government, it could be the contractor, and increasingly it could be outside investors who are just looking at this purely from a financial point of view. Their contribution isn't all upfront, but it's staggered. So when key milestones are met, there will be additional payments, and usually the payments of equity follow the payments of debt. And what that means is that the debt to equity ratio in the transaction is maintained.