Equity Finance

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Overview

Equity finance refers to the capital raised by selling a stake in the business or project itself. The equity capital market is also called stock market.

RE equity investments involve investments by a range of financial investors including Private Equity Funds, Infrastructure Funds and Pension Funds, into companies or directly into projects or portfolios of assets.

Different types of equity investors will engage depending on the type of business, the stage of development of the renewable energy technology (RET) and the risk associated with it (See the table below for more information). For instance:

• Venture Capital is focused on 'early stage' technology companies
• Private Equity firms focus on later stage financing of more mature technologies or projects. They generally expect to exit their investment and make returns in 3-5 year.
• Infrastructure Funds are interested in lower risk infrastructure such as roads, rail, grid, waste facilities etc, which tend to have a longer term investment horizon and thus expect lower returns over their period.
• Institutional Investors such as Pension Funds have an even longer time horizon and larger amounts of money to invest. They have a lower risk appetite.

Funds use Internal Rate of Return (IRR, or ‘rate of return’) of each potential project as a key tool in reaching investment decisions. It is used to measure and compare the profitability of investments. "IRR is simply the percentage gain the fund earns on a specific investment over the life of that investment , expressed in the form of an annual rate of interest". Funds will generally have an expectation of what IRR they need to achieve, known as a hurdle rate.

There are a large variety of specialized funds that track certain baskets of stocks in bothe

Funds Providing Equity

Features of Funds Providing Equity
Venture Capital Funds	Money raised from a wide range of sources with high risk appetite to include insurance companies, mutual funds, high net worth individuals Target new technology, new markets Interested in early-stage companies High risk of failure in every venture Investment horizon around 4-7 years Return requirement, many multiples of original investment (50 – 500% IRR)
Private Equity Funds	Money raised from a wide range of sources with medium risk appetite to include institutional investors and high net worth individuals Target opportunities with possibility for enhanced returns (or‘upside’) Interested in companies and projects with more mature technology, including those preparing to raise capital on public stock exchanges (‘pre IPO’), demonstrator companies, or under-performing public companies. Shorter investment horizon, 3-5 years Higher return requirement, 25% IRR
Infrastructure Funds	Funds drawn from a range of institutional investors and pension funds Target ‘infrastructure’ i.e. an essential asset, long duration, steady low risk cash flow Interested in roads, railways, power generating facilities Medium term investment 7-10 years Low risk and return, 15 % IRR
Pension Funds	Typical investments include: - Public equity (via stock markets) - Corporate and government bonds - Real estate - Inflation-linked assets (such as commodities, inflation linked bonds, infrastructure and energy, forest land) - Private equity - Cash and cash equivalents Investing directly they seek ‘cash yielding’ investments, i.e. those that generate a stream of cash year on year, as opposed to an investment in which all cash is realised at the end of the investment period through an ‘exit’ (by either sale or IPO). These investments are required to support their long term liabilities; For these investments they display a low risk appetite, reflected in expectations of stable returns at around the 15% level; In RE they make very low risk investments e.g. a portfolio of operational onshore wind assets; As they have very large funds to invest, they do not commonly get involved in individual projects.They may allocate monies to specialised Private Equity or Venture Capital funds (including infrastructure or renewable energy funds) that manage the investments and provide the pension funds with a return; A handful of specialised RE bonds have been issued which have been of interest to pension funds. Risks are described in the project bond issue documents. Project risks will be extensively mitigated (such as reserve facilities, for example for maintenance problems, distribution restrictions, cash sweeps) in order for the project to attract “an investment grade rating” making it attractive to investors (a higher rating suggests less risk that the project will default on its bond obligations leaving bond investors at risk of not being repaid).
Source: Adapted from

Further Information

• Financial Instruments & Support for Renewable Energy