Dieter Kerschbaumer, advisor at Arc & Co.

Equity Masterclass: a pivotal tool for development funding

Introducing a five part series of masterclass articles into equity funding, and the vital role this can play within development finance.

Over the past 12 months, Arc & Co. has experienced an uptick in enquiries from developers looking to raise equity funding for their projects. This trend underscores the importance of equity investment as a pivotal tool within the development finance structure.

Equity investment can significantly reduce the capital contribution required by a developer in a scheme, allowing their monies to be spread across multiple projects. This diversification not only potentially increases their return on investment but can also help scale their business and portfolio.

To increase awareness, understanding, and to support borrowers seeking to raise equity investment for their future projects, we’ve put together a five-part Equity Masterclass educational series, published on a fortnightly basis. Each segment will also contain an example case outline to showcase the equity funding in action.

The Equity Masterclass breakdown

1.       The what, why and when of equity.
2.       Structuring the capital stack, SPVs and shareholder agreements (single schemes).
3.       Maximising growth; equity investment at corporate level (multiple schemes).
4.       Internal rate of return vs. equity multiple.
5.       Investor appetite and how to source equity.

The what, why and when of equity

First, what is equity investment? Equity investment is a method of raising capital through a partnership with an investor, in exchange for equity shares with profit sharing and decision-making privileges in a development.

This type of funding can be secured for a single scheme or at corporate level for multiple schemes across several years. There are no set parameters when structuring equity, which we will explore in the next segment: Structuring the capital stack, SPVs and shareholder agreements
Why equity should be considered

Equity investment can reduce a borrower’s own capital input, through achieving higher leverage up to 90-100% of the total development cost, including 100% of build costs and monies towards the purchase, whereas mezzanine (second charge) lending may only facilitate up to 90% total cost.

This means developers can input less of their own monies into a scheme, enabling them to take on more projects, where funds would otherwise be tied up in their current schemes and/or they would not have sufficient borrower equity to proceed via a traditional debt funding route.

By way of example, here is a case study involving the development of six apartments.

Appraisal summary

  •  Purchase costs at £1,308,450.
  •  Construction cost at £1,182,738.
  •  Total cost at £2,491,188.
  • GDV at £3,670,000.
  •  Pre-finance – profit at £1,178,812 / profit on cost at 47%.

Senior debt 1st charge – 60% LTGDV

  • Senior loan towards construction 100% at £1,182,738.
  • Senior loan towards purchase 57% at £743,934.
  • Senior debt cost at £280,326.
  • Post finance – profit at £898,486 / profit on cost at 32%.

JV partner equity input – 100% LTC

  • Investor towards purchase at £564,516.

When equity should be raised

Engaging equity investors should coincide with approaching debt lenders. Outline discussions are fundamental in establishing appetite and which parties will be working together. The combination of funding providers involved in a project needs to be suitable and compatible.

This approach streamlines structuring the capital stack and provides confidence to all parties. Keep an eye out for the next instalment of this series in the coming weeks, in which we tackle structuring the capital stack, SPVs, and shareholder agreements (single schemes)

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