3 types of oil and gas institutional financing

In essence, there are three fundamental types of institutional finance – senior debt, mezzanine debt, and equity, reported the Oil and Gas Financial Journal

Senior debt
Senior debt is generally secured by the assets of the subject project, and will carry advance rates of up to 100% of the market value of the assets financed. In some cases, e.g. early in a project, senior lenders will overadvance in order to accelerate growth. In return they will require some upside or equity participation. These deals are typically mature in three to five years, with the repayment schedule tailored to the budgeted cash flows.

This type of financing is the least expensive, with compensation to the lender primarily in the form of interest and fees paid on the debt. In cases where the lender is well secured and cash flow is anticipated to accelerate later in the project, investors may agree to add interest payments to the principal amount in lieu of cash payments (“PIK” interest) for a period of time.

Senior debt usually has financial covenants that are more restrictive than mezzanine or equity financing. However, we always make sure our clients have a reasonable covenant cushion to allow for cash flow deviations.

Mezzanine debt
This is usually structured as a hybrid between senior debt and equity. For projects that carry a higher degree of risk than those financed with senior debt, this type of financing can be a perfect solution.

We often utilize mezzanine debt structures in high growth situations. For example, a fledgling E&P project may have big expectations, but initially the funding need may exceed the asset value. Because the investors have an “upside” component in the form of well working interests and/or equity, they will assume this additional risk since it could result in a substantial future payoff.

While generally not as restrictive as senior debt, mezzanine debt will have financial covenants that are based on the financial proformas. As with senior debt, the financial covenants have a cushion built in and allow for normal business events.

Equity
This type of financing is the most flexible, but is also the most expensive. There is typically no maturity and/or investors generally will not require any fixed payments of dividends, but there may be provisions that provide for distributions once certain performance hurdles are met.

This is a good fit with management teams that have little or no assets to contribute or with projects that are relatively risky, but have the possibility of a big payoff in the future.

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If you found this helpful you might want to learn what the pros and cons of debt financing are here