This Toolkit item relates to
Part 2 - Investment Governance, Funding and Financing of the Commonwealth Investments Resource Management Guide.
What is equity?
Equity financing is where the Government takes an ownership interest in an entity in anticipation of future returns (via dividends and/or capital returns). The company can be either a private sector business, or a Government-owned business. The entity must be outside the general government sector (GGS).
When should I use equity?
There are a number of considerations to be balanced in determining the most appropriate non-grant financing option (or blend of options).
Equity investment is most commonly used to address a market gap where there is a shortfall from other parties or where there are risks that the private sector is unwilling to take and where the Government is seeking the ability to influence the strategic delivery of policy objectives.
Equity investments generally offer more control but less certain financial returns, usually expected well into the future. See further guidance on Q&A – Equity investments.
Characteristics of equity
| Characteristic |
Details |
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Ability to influence financed objective
Medium-High
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The Commonwealth should be able to exercise reasonable control over its investment, including the ability to sell, transfer or redeem its shareholding.
With majority ownership, Government has significant influence in most areas of the company’s strategic direction – company documentation such as constitutions, Board appointments, regular reporting, annual operational budget ratification, debt agreements and corporate planning.
For part ownership - the Government may or may not have control over the strategic outcomes of the company but needs to consider flexibility in relation to its investment (including sell its share without unreasonable impediment).
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Level of market intervention
Medium-High
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A 100% ownership stake represents a high intervention in the market. Equity investment is most commonly used to address a market gap where there is a shortfall from other parties or where there are risks that private sector is unwilling to take and where the Government is seeking the ability to influence the strategic delivery of policy objectives.
A part ownership stake represents a medium to high level of intervention, depending on the size of the Commonwealth’s stake.
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Commercial discipline incentive
Low-Medium
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Equity does not deliver the same financial discipline as a loan. As the Commonwealth’s investment in a project is inherently more risky than the provision of a grant or loan there should be appropriate discipline and monitoring of the development and operation results to manage the investment prudently to deliver value-for-money outcomes. This should include the implementation of robust monitoring and reporting mechanisms on the Company’s performance, so the Government acts an active investor. |
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Certainty of financial return
Low
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The long-term nature of equity investments harbours inherent volatility and uncertainties which impact the timing and value of returns. |
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Opportunity to realise upside gain
Medium-High
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Unlike debt, equity holders benefit from upside risk. This may include revenue exceeding expectations, resulting in higher returns to shareholders. |
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Level of financial risk
High
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The combination of low certainty of financial return and low security over underlying assets results in the level of financial risk for equity – or the risk of loss of the investment – being high. Government equity may be appropriate for projects or programs that have a significant timing difference between capital outflows and positive net cash flow and a return to equity (i.e. a “patient” investor who can wait until the longer term revenues arrive). This makes equity ideal for extremely lengthy development periods. |
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Security of asset
Low
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Should the business enter insolvency (usually administration or liquidation), equity holders have the last claim on assets ranking after secured and unsecured creditors, including lenders. |
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Administration costs
High
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Initially high administration for the Commonwealth and the Delivery Vehicle in establishing governance arrangements for the Equity Agreement. Active oversight is required as an equity investment is typically seeking to deliver a specific objective of Government and therefore it requires greater governance costs for Government to ensure the objectives of the investment are being realised.
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Accounting and budget classification and reporting of equity
Accounting Standards require equity to be classified on the basis of its economic substance, rather than its legal form. This means that regardless of what legal documents state, equity must continue to meet certain accounting tests[1] to be classified as equity. To be treated as equity for budget accounting purposes, the expected return on capital must be at least equal to the long-term inflation rate and there should be a reasonable expectation that the investment will be recovered. More information on recognition in Budget aggregates is available here.
Examples of Commonwealth equity investments
NBN Co
The Commonwealth provided $29.5 billion in equity in exchange for 29.5 billion ordinary shares (with a face value of $1.00 per share). The last equity drawdown was received by NBN Co in September 2017. NBN Co only has fully paid ordinary shares in issue, all of which are owned by the Commonwealth.
WSA Co
WSA Co is party to an Equity Agreement with the Commonwealth, which formalises the intention of the Commonwealth to provide equity to the company for the purpose of developing and operating Western Sydney Airport. WSA Co has fully paid ordinary shares in issue, all of which are owned by the Commonwealth. Commitment to invest up to $5.3 billion in WSA Co to develop and operate Stage 1 of Western Sydney Airport by the end of 2026.
