The infrastructure project development environment is extremely difficult to operate within. Many people claim to be project developers, but when asked how many projects they have developed, they always have many stories but few completed projects.
This phenomenon gives project development a bad name, and many project houses do not want to work for project developers as they feel the risks associated with non-payment and projects not proceeding to the execution phases are too high.
The following project development model was created based on experience working with various project developers and developing projects in Africa and internationally. By following the steps outlined below, project developers can improve their chances of closing projects, reduce development costs and time, and enhance the perception of project development.
1. Infrastructure Project Development: Business Case
Before anything gets done on a project, ensure that your project has a real business case. This does not mean building Excel spreadsheets or writing long documents. It means to do one A4 page business case for your project. A project is like a business; you have input, a process and an output. Start by who wants to buy, pay or lease the product or infrastructure you plan to develop. Once you identify the potential parties, understand what inputs you need to produce the outcome. Do high-level economics calculations for your project and ensure they make sense. Work out your turnover, profit, and payback period for a budgetary CAPEX. This should all fit on one A4 paper and give you an answer to proceed with the next step or not.
2. Offtake
Once you understand your business case for your project and feel comfortable that you can pay the capital required back in a certain number of years, you need to sign up your offtake term sheet. This should be the first step before spending money on developing your project. You won’t know exactly what to charge for your product or service at this stage, but you will have a feel for it and agree on certain terms with your offtake. This will be done on a term sheet basis.
3. Infrastructure Project Development: Feasibility Study
Suppose you feel confident that you have somebody willing to buy your product or service, and you have some form of a document signed that they are willing to pursue the project further. In that case, you can start looking at a feasibility study for your project. You will encounter several consultants wanting to do the feasibility study for you at enormous prices, and all of them will claim that they know exactly what to do. However, in reality, the experience in project development from African consultants is very limited. You do not need a massive feasibility study to show whether your project works. The term bankable feasibility study is used, but not many people understand what a bankable feasibility study is. You need an engineering study that gives you a +-10% CAPEX for the infrastructure with a financial model showing the project makes sense.
4. Internal Rate of Return (IRR)
The project development world is all about the internal rate of return. In layman’s terms, it considers several factors and works out the hurdle rate of return for investors and bankers. A typical dollar-based IRR ranging from 10% to 20% would be sufficient for most investors, depending on their risk appetite in Africa. This IRR should tell you if your project makes sense and also give you a firm indication of what you can sell your product or service for. Once you get these results, you need to revisit your off-taker and discuss the price you can offer the service or product to them. You can proceed if they are still happy to proceed and sign up for this price. If you don’t get the buy-in from your off-taker, you need to stop, look for different off-takers or remodel your project to get your off-taker signed up. Many developers make the mistake of proceeding after this point without having anybody willing to take their product or service. This only leads to a lot of money being spent on development without any real prospects for the future.
5. Infrastructure Project Development: Location
Proceeding to the next phase, you need to find a facility where you will place your infrastructure. This process takes time, and finding the correct piece of land is very important. This also comes with a big cost, as you must purchase the land or sign a long-term lease. Many landowners are willing to negotiate with you, but they also want answers and cannot necessarily wait for your project to work before they get a commitment from you. Some landowners might be interested in providing their land as equity in the project, but this does not often happen. If you have a solid project, it’s a very expensive way of purchasing land. Things that should be considered during land negotiations are the environmental approvals and rezoning of the property.
6. Environmental
In South Africa, there are essentially two types of Environmental Impact Assessments (EIAs). The first is called a basic assessment; this usually takes about six months to complete, and it’s not very expensive. The other type is called a full EIA and can take anywhere from 12 to 18 months to get approved. The type of EIA required depends on the specific infrastructure involved, making it essential to identify the necessary assessment early on and get the process moving as soon as possible. The environmental process will also need technical inputs from your engineering consultants, so getting a group that understands and has experience in the infrastructure you are planning to develop would help a lot. African EIAs can be done in shorter timeframes, but investors usually want international standards, which will add many extra requirements.
7. Rezoning
During the land purchase, the zoning plays a major role. If, for instance, the land is still zoned for agricultural use, it will be much cheaper than industrially zoned but will take a long time to rezone. Rezoning can take up to 3 years, so it’s very important to understand what zoning classification your project would require. Any good town planning outfit that knows the area would be able to assist with the zoning of the land and the required zoning for the typical infrastructure you plan to erect. Bulk contributions also have a major impact on the development costs for a project and should not be underestimated. If a property does not have enough power or water for development, the upgrades are very expensive and take a lot of time.
8. Infrastructure Project Development: Regulatory Framework
After all the issues associated with land acquisition, the biggest challenge is the regulations in the country where the project is planned. Depending on the project, several bodies regulate the infrastructure, and you will have to apply for the correct licenses to operate the infrastructure. The licensing process can also take a long time, so the earlier you identify the required licenses, the sooner you can secure them and move forward.
9. Social Impact
Something often overlooked is a project’s social impact on the communities around it, which can be both positive and/or negative. Still, it is important to understand the existing social environment and measure the project’s impact on this environment. Most financial institutions would require a thorough social impact assessment before investing in your project.
10. Infrastructure Project Development: Finance
Several places in South Africa and abroad offer development finance as part of their suite. In reality, development finance is almost impossible to access. Some parties offer grant funding, especially when it’s a green and environmentally friendly project. Other institutions like the DBSA (Development Bank of South Africa) and PIC (Public Investment Corporation) would offer development funding in South Africa and Africa. Still, they are very selective, and you usually need all the boxes ticked in terms of EIAs, land and a bankable feasibility study. The PIC would be willing to fund 50% of the development in some instances, especially in Africa, but you will have to provide the other half in cash before their funding takes effect. If you find somebody willing to provide development funding, it will be very expensive, or they would want a large part of the equity in the project. The best way to overcome development funding is to keep the upfront costs as low as possible. You will, however, need some money for the upfront developments, which can be funded from previous savings, leveraging off existing assets, or selling equity in the project. Some project developers raise development funding on the stock markets but note that listing a company on the stock exchange is expensive and a big administrative burden.
11. Project Finance
Once your bankable feasibility is done, your EIA is approved, land rezoned and purchased, all regulatory requirements have been adhered to, offtake and supply agreements have been signed, you are ready to approach institutions for project finance. Project finance is speciality finance that caters to projects and uses the project as a ring-fenced business. Project finance is usually broken into two components: debt and equity. You will often hear the term debt-equity ratio. It means the percentage of debt and equity the project would attract.
12. Infrastructure Project Development: Debt
Most commercial banks are willing to provide up to 70% of the project’s value in the form of debt. This would usually be done at a relatively good interest rate, depending on the type of project and the location. Banks will have a very stringent due diligence process and usually appoint technical and commercial advisors to evaluate the project’s viability. The rest of the money would have to come from private equity investors or the project developer itself.
13. Private Equity
Several private equity investors in Africa and abroad are willing to invest money into projects. Some funds focus on Africa, while others focus on certain types of infrastructure. They all have the same model: they get funds from individuals, pension funds or businesses to invest and need to optimize their return on investment for their investors. Private equity investors usually want to optimize the IRR of the project, and they base their offers on the IRR the project makes. In layman’s terms, the higher the IRR of your project that you are busy developing, the more interest you would get from private equity and the stronger negotiating position you will have. It’s usually good to speak to several private equity funds until you find the fund that works for you. Building a strong relationship with a fund or two also works well if you develop multiple projects.
14. Other Types of Funding
Several other options exist to fund projects, but this article will not go into detail about each option, only mention some of them. Export credit is a good way to secure funding from certain countries if the equipment is sourced from that country. Crowdfunding is also becoming popular for funding certain projects, but it is still in its infancy. Venture capital has become very strong in America, and even in South Africa, SARS has established the 12j vehicle to encourage venture capital in the country. These offerings can all be tapped into to fund projects and optimize project funding.
15. Owners Engineers
After project funding strategies are determined, it’s a good time to appoint owners’ engineers to the project. The company that provided the feasibility study services is usually favoured for this role, as they already understand the project dynamics. Still, this company doesn’t have to be appointed for the owner’s engineer role. The owner’s engineer would usually be responsible for developing the scope of work for the EPC-and-O&M Contractor and managing them during the execution phase of the project. Thus, the owner’s engineer must understand the type of infrastructure involved and the experienced and bank-approved EPC and O&M contractors.
16. Infrastructure Project Development: EPC Contractor
Selecting the correct contractor and engaging with them early will increase the likelihood of achieving success with the project. Many contractors encourage early engagement with developers and even help them with certain items at risk to secure the downstream work. It should, however, be noted that at the end of the day, the banks decide on the contracting strategy and the type of contractor selected. If the project finance route is selected, the banks want the main contractor to be appointed on an EPC basis with a single point of responsibility. They also want the contractor to have a balance sheet equal to or more than the project value. This is very important to them as they see it as reducing the project’s risk. Having experience in the type of infrastructure to be erected also plays a big role.
17. Operations and Maintenance Contractor
It’s also very important that the asset gets operated and maintained correctly to ensure the returns are realized over the total life cycle of the project. This is usually done by a separate contractor specialising in this work scope. Project finance will also not be released until the O&M contractor is approved and appointed.
18. Infrastructure Project Development: Execution
Once all the contracts have been signed with contractors and off-takers, and all the environmental and regulatory conditions have been met, you are finally ready to execute the project. The process from starting development to being in a position to start building takes several years to complete. During execution, both cost and schedule are very important to the developer as they have built both those items into their economic models. If one of those items slips, it severely impacts their payback periods to the lenders and private equity investors. They usually also insure against cost overruns and slippages on projects like these. Once the EPC contractor has completed the execution phase of the project, the developer usually gets the contractor to commission the infrastructure with support from the client and owner engineer as required.
19. Operations
Once the asset is live, the O&M contractor will take it over and ensure it performs as expected. The EPC contractor usually has a 52-week defects liability period, during which they will repair any defective works. Once this period ends, the O&M contractor will continue with maintenance and repairs as needed.
20. Conclusion
Although project development takes a long time and faces many burdens during the development phases, it can pay off in the long run. It also gets easier once you have developed one project as you build credibility and equity to fund future developments. Once a team develops a project together, they often stick with the same team for many years and develop several projects together. This leads to sustainable work for all the parties involved.
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