Notice. This page is informational and general in nature. Any financing outcome remains subject to lender underwriting, KYC and AML controls, sanctions screening, legal documentation, third-party approvals, and project-specific diligence.
Why Project Finance Relies Heavily on Debt
Project finance is built around one idea: repay lenders from predictable project cash flows, not from the sponsor’s full balance sheet. When the revenue contracts, cost base, and control package are credible, debt becomes the main funding engine.
This page explains why leverage is typically high, how lenders size it in practice, and what sponsors must document to close non-recourse or limited recourse facilities.
Contact The Project Finance DeskThe Core Reason Debt Dominates Project Finance
A well-structured project is designed to behave like a cash flow machine. Contracts define revenue, operating obligations, and who carries which risks. The financing then follows the cash flow. In that setup, debt is not “extra leverage.” It is the instrument that converts contracted future cash into upfront capital.
Sponsors usually prefer this approach because it limits the equity check, preserves corporate borrowing capacity, and can improve equity returns when the project performs. Lenders prefer it because the deal is governed by security, controls, and a contractual framework rather than pure sponsor credit.
Related internal reading: PPP and Project Finance Transaction Advisory and Project Finance Debt Structuring.
What Lenders Actually Underwrite
In project finance, lenders underwrite stability and enforceability. They want proof that the project can keep generating cash, and that cash can be captured and applied to debt service even if relationships get stressed.
- Revenue quality: contracted offtake, tariff regime, or other predictable payment logic, including remedies and step-in rights where relevant.
- Cost realism: operating cost assumptions that match the technical plan, maintenance, and local realities.
- Construction certainty: completion support, EPC terms, guarantees, and clear delay and LD mechanics.
- Cash flow control: accounts structure, cash waterfall, reserve accounts, and restrictions on leakage.
- Security package: pledges, assignments of contracts, insurance, and other enforcement pathways.
Lender-aligned modelling is usually where weak projects get exposed early. See: Project Finance Financial Modelling and Financial Modelling for Renewable Energy Projects.
How Debt Is Sized in Practice
Debt sizing is not a guess. It is a function of DSCR, downside cases, reserve requirements, and covenant headroom. The model is run under stress cases to see if the project can still pay debt on time.
| Debt Sizing Input | What It Means | Why It Matters |
|---|---|---|
| DSCR | Cash available for debt service divided by scheduled debt service | Sets the maximum leverage and forces downside resilience |
| Base case and downside cases | Volume, price, availability, delay, and cost stresses | Shows whether the project survives real-world volatility |
| Reserve accounts | DSRA and other locked cash buffers | Protects lenders when cash timing slips or performance dips |
| Covenant headroom | Distance to covenant triggers under stress | Prevents early default from normal operating variance |
| Amortisation profile | How fast principal is repaid and how it matches the asset life | Aligns repayment with cash generation and project maturity |
If the file cannot explain why the proposed leverage is safe, lenders will either cut leverage hard or walk away. That is one reason project finance leans on debt only when the documentation and controls justify it.
Why Sponsors Like Debt in Project Finance
- Equity preservation: sponsors can fund more projects with the same equity pool.
- Risk ring-fencing: the project risk sits in the project structure, not across the whole corporate group.
- Return mechanics: when performance is stable, leverage can improve equity outcomes.
- Capital markets logic: once a platform has track record, debt can scale faster than equity fundraising.
Where the capital stack needs a bridge or a gap tranche, see: Project Finance Equity Bridge and Mezzanine Solutions.
Why Lenders Accept High Leverage Only With Controls
Lenders will not “trust the plan.” They will trust the controls. A debt-heavy capital stack only works when cash is governed by documents and account mechanics.
Cash Waterfall Discipline
A typical waterfall prioritises operating costs required to keep the asset running, then debt service, then reserve replenishment, then distributions. The exact order is negotiated, but the logic is consistent: keep the project alive and keep debt current before equity takes cash out.
Covenants and Triggers
Covenants are not paperwork. They are early-warning sensors. If DSCR drops, if reserves are not funded, or if costs drift, covenants force intervention before a full default event.
Structured credit principles carry across both project and corporate debt. See: Structured Debt Advisory Services.
Non-Recourse vs Limited Recourse in Real Transactions
Non-recourse is often overstated in marketing. In practice, most transactions include limited recourse features somewhere in the package. That can include completion support, contingent sponsor support, or specific guarantees tied to clearly defined risks.
- Non-recourse: lenders rely mainly on project cash flows and project security, with limited sponsor exposure.
- Limited recourse: sponsors support specific risks, often during construction or early operating ramp-up.
This is not a weakness. It is how bankability is engineered. Lenders want to know who carries construction risk, who carries performance risk, and what happens if the project does not meet its technical plan.
When More Equity Is the Right Answer
Debt-heavy structures are not universal. Projects lean more equity-heavy when revenue is not contracted, when the regulatory regime is uncertain, when construction risk is high, or when early operating volatility is unavoidable.
- Early-stage projects with weak contract coverage
- Assets with material permitting or land uncertainty
- Projects with merchant exposure and no reliable price floor
- New sponsors without an execution track record
In those cases, the correct answer is not “more leverage.” The correct answer is tighter contracts, stronger governance, de-risking milestones, or more equity until the project is financeable.
Common Misconceptions
- Misconception:
project finance debt is cheaper because it is “secured”.
Reality: pricing follows risk, documentation quality, and controls, not labels. - Misconception:
a strong sponsor guarantees high leverage.
Reality: a strong sponsor helps, but lenders still underwrite project cash flow and enforceability. - Misconception:
the model is the deal.
Reality: the contracts and controls are the deal, the model only proves they are consistent.
FAQ
Why is project finance often 70% to 80% debt?
Because lenders can be repaid from contracted cash flows when the project has enforceable contracts, a credible operating plan, and strong cash control mechanics. Without those, leverage drops quickly.
What is the single most important metric for debt sizing?
DSCR. It is the lender’s core test of whether cash flow can reliably cover debt service, including stress cases and covenant headroom.
What makes a project finance model lender-ready?
Contract-linked revenue, realistic operating cost inputs, scenario analysis, clear reserve assumptions, and a cash waterfall that matches the proposed term sheet.
Do project finance loans always have no sponsor support?
Rarely. Many deals include limited recourse elements, especially around completion, ramp-up, or specific risks that lenders will not carry without support.
What documents usually matter most to lenders?
The offtake or revenue contract, the construction framework (including EPC terms), permits and key approvals, insurance structure, and the accounts and security package.
When should sponsors expect lenders to reduce leverage?
When revenue is merchant or uncertain, when construction risk is high, when regulatory risk is material, or when the file cannot prove enforceability and cash control.
If you want leverage that survives committee scrutiny, the focus is not headlines. It is contracts, controls, and a model that matches reality. Contact the desk for a confidential review.
Contact The Project Finance DeskDisclosure. FG Capital Advisors is not a bank and does not provide direct lending. Services are advisory and arrangement support delivered with third-party lenders and regulated counterparties, subject to diligence and definitive agreements.
