The financial structure of infrastructure projects is a critical aspect that is often overlooked. A recent example highlights the importance of proper financial structuring. Two solar projects in different countries sought similar amounts of capital, around $150 million, with similar technology, construction timelines, and generation capacity. However, one project reached financial close in just 11 months, while the other took two years and had a cost of capital nearly four percentage points higher. The difference lay in their financial structure, with the first project having a capital stack designed to match its risk profile.
A capital stack is not just a fundraising exercise, but an engineering decision about distributing a project's risk across different capital providers. Commercial debt, equity, subordinated or mezzanine capital, and concessional finance or grants each have distinct roles to play in funding a project. Commercial debt funds the most predictable, lowest-risk portion of a project's cash flows, while equity absorbs residual risk and demands a higher return. Subordinated capital sits between the two, absorbing more risk than senior debt for a higher return.
The question that should be asked of every infrastructure transaction is not "how much capital does this need" but "what problem does each layer of this capital stack need to solve, and is the right instrument solving it?" A well-designed capital stack protects senior capital by ensuring it only absorbs the risk it is priced to hold. This allows commercial lenders to offer competitive terms in the first place. A project with no subordinate or first-loss capital ahead of senior debt forces that debt to price as though it were equity.
The useful way to think about a capital stack is architectural, as a structure that sequences and distributes risk deliberately. A well-designed stack sequences risk across the project's life cycle, matching development-stage capital to development-stage risk, and construction-stage capital to the construction period. It also extends tenor by allowing patient capital to take the portion of the project that benefits most from a longer repayment horizon.
Blended finance has become a popular answer to structural gaps in infrastructure capital stacks, but it deserves more scrutiny. The honest test of any blended structure is not whether concessional capital was deployed, but what that capital actually did. The goal of blended finance should be to provide a solution to a specific problem, rather than just celebrating its deployment.
The Missing Middle of Financial Structure refers to the gap between the general availability of different layers of capital and the specific, deliberate assembly of those layers into a stack matched to a given project's actual risk profile. This inconsistency is precisely where the Missing Middle sits. Standard project finance discipline can be applied to address this issue, but it is applied inconsistently.
The article argues that the industry's habitual response to the infrastructure gap – more financing, more pledges, more capital raised – routinely ignores the importance of financial structure. To address the infrastructure gap, it is essential to focus on building a well-structured capital stack that matches the project's risk profile. This requires a deliberate and thoughtful approach to distributing risk across different capital providers.
Key points
- Financial structure plays a crucial role in determining whether capital financing fits the risk it carries.
- A well-designed capital stack sequences risk across the project's life cycle and matches development-stage capital to development-stage risk.
- Blended finance deserves more scrutiny to ensure that concessional capital is used effectively to solve specific problems.
