The Construction Facility, IDC and Drawdown Order: Why Paying More Interest Is Usually the Right Answer

There are three ways to fund a construction budget: equity first, pro rata, or debt first with equity committed at the end. Sponsors are often told that equity-first is the conservative choice and debt-first is aggressive, because debt-first accumulates more interest during construction.

That is true and it is the wrong conclusion. On a $250m project over 24 months:

Equity first    IDC + fees  $11.69m    Equity PV outflow  $59.06m
Pro rata        IDC + fees  $13.63m    Equity PV outflow  $55.27m
Debt first      IDC + fees  $15.58m    Equity PV outflow  $51.60m

Debt-first costs $3.89m more in interest and commitment fees. It saves $7.46m of equity present value, because the equity cheque is written on average fourteen months later.

Net gain to the sponsor: $3.57m. And the rule generalises — whenever the equity discount rate exceeds the all-in cost of construction debt, which is essentially always, deferring equity is worth more than the IDC it costs.

This post covers how a construction facility actually works, how IDC is computed, why the drawdown order is a returns decision rather than a prudence decision, and where the circularity comes from.

ℹ️ Note: All figures are labelled assumptions, on a cosine S-curve drawdown profile. The direction of the result is robust; the magnitude depends on the spend profile and the rate spread.

What Is a Construction Facility?

A committed loan drawn in instalments against certified construction progress, converting to a term facility at completion. It is not disbursed in one sum: the borrower requests drawings as costs fall due, each request satisfying conditions precedent and supported by a certificate from the lender's technical adviser.

The essential difference from the term facility is that during construction there is no revenue and no CFADS. Nothing is repaid, coverage ratios do not exist, and the lender's protection comes from completion support, the construction contract, and the technical adviser rather than from cash flow.

How Does the Drawdown Actually Work?

Four mechanisms, each of which can delay money.

An availability period. The facility can be drawn only within a defined window, typically construction plus a buffer. Drawings outside it require consent, and an extension is a negotiation held at the worst possible moment.

Conditions precedent, initial and recurring. The first drawing requires the full CP list — security perfected, insurances in place, permits obtained, contracts executed, equity contributed or committed. Every subsequent drawing requires a shorter list, which typically includes no default subsisting, representations repeated, and the project remaining on budget and on schedule.

Certification. The lender's technical adviser certifies that the works claimed have been performed and that the remaining budget is sufficient to complete. That second test is the one with teeth: a project that is on schedule but has consumed its contingency can fail the cost-to-complete test while every physical milestone is met.

Milestone linkage. Drawings are matched to construction progress rather than to an agreed calendar, which means a delayed project draws later, incurs less IDC, and — as the delay LD posts in Series D set out — may still be paying damages on four different clocks.

What Is IDC?

The interest accruing on drawn amounts during construction, capitalised into project cost rather than expensed.

Capitalisation is the natural treatment because there is no revenue to pay interest from. The cash is either funded from the facility itself — a drawing to pay interest on earlier drawings — or from a dedicated interest reserve, and either way it increases the amount ultimately outstanding.

Two consequences follow, and both matter more than the accounting.

IDC is part of the project cost that the gearing test applies to. More IDC means a larger project cost, which on a debt-to-capital test means a larger facility, which means more IDC. That is the construction-phase circularity the sculpting post identified as a loop separate from the operating sculpt — and one that is genuinely algebraic rather than an artefact of how the model was built.

IDC is a real cost, not a timing item. It is capitalised, financed, and repaid with interest over the term. A project with $15.6m of IDC has $15.6m more debt outstanding at commercial operation than one with none, and that additional balance consumes coverage for the life of the facility.

Commitment Fees: The Offset

The reason the trade is not one-sided.

A commitment fee accrues on the undrawn portion of the facility, typically at some fraction of the margin. A structure that draws debt late leaves a large undrawn commitment for longer and pays more in fees; a structure that draws early pays less.

That produces a partial hedge against the IDC effect, visible in the worked numbers:

Order	IDC	Commitment fee	Total
Equity first	$9,382,003	$2,306,615	$11,688,618
Pro rata	$11,679,687	$1,953,125	$13,632,812
Debt first	$13,977,372	$1,599,635	$15,577,007

The fee moves in the opposite direction to IDC and is smaller — about 15% of the IDC swing on these assumptions. So the net financing cost still rises as debt is drawn earlier, but by less than the interest alone suggests.

Worth noting: the commitment fee is the reason a facility sized generously "for comfort" is not free. An oversized construction facility that is never fully drawn pays fees on the unused portion for the whole availability period, and that cost is real.

The Three Orders, and What They Actually Trade

	Equity first	Pro rata	Debt first
Lender comfort	Highest	Standard	Lowest
IDC + fees	$11.69m	$13.63m	$15.58m
Weighted avg equity month	5.7	12.5	19.3
PV of equity outflow	$59.06m	$55.27m	$51.60m
Net benefit vs equity first	—	$1.85m	$3.57m
Requires	Nothing	Nothing	Sponsor credit

The last row is the constraint. Debt-first works only where the lender will accept a promise instead of cash — an equity commitment agreement from a creditworthy parent, or a letter of credit securing the contribution. A developer without that covenant cannot access the structure, however good the arithmetic.

That makes the drawdown order one of the few structural terms where sponsor balance sheet strength converts directly into project returns, independent of anything about the project itself. Two identical assets built by different sponsors will have materially different equity IRRs because of it.

What Happens If the Budget Is Exceeded?

A layered set of answers, and the order in which they are consumed is itself a structure.

Contingency is the first line — an amount within the budget, typically a single-digit percentage of construction cost, drawable on the same terms as any other cost but often subject to lender or technical adviser consent above a threshold. Contingency is part of the financed budget, so drawing it increases debt and IDC.

A cost overrun facility may sit above it: a committed but separate tranche, available only once contingency is exhausted, usually at a wider margin and with tighter conditions.

A sponsor cost overrun undertaking is the layer lenders rely on most. The sponsor agrees to fund any cost to complete beyond the financed budget, as equity or subordinated debt, typically uncapped or capped at a large multiple of the contingency. It is the mechanism by which completion risk is transferred out of the project and onto the sponsor's balance sheet, and its value is entirely a function of that balance sheet.

The cost-to-complete test is what forces all of this to happen at the right time. Each drawing requires a certificate that the remaining available funds are sufficient to complete the works. A project that fails it cannot draw — and the remedy is for the sponsor to inject the shortfall, restoring the test before construction can continue.

That test is worth understanding as the real completion covenant. It is forward-looking, it is certified by a third party, and it bites long before any physical milestone is missed. A project whose contingency is being consumed faster than its progress is, on this test, already in trouble — which is why contingency drawdown rate against percentage completion is one of the more useful things to monitor during construction, and one of the less commonly reported.

What Is Completion, and Who Certifies It?

Two different completions, and the distinction decides when the sponsor's support falls away.

Physical completion is the construction contract's concern — mechanical completion, substantial completion, commercial operation, as the first Series D post set out. It is certified under the EPC contract and triggers the contractor's obligations and liabilities.

Financial completion, sometimes called project completion or term conversion, is the financing's concern. It is a defined set of tests in the credit agreement, and satisfying it converts the construction facility to the term facility and releases the sponsor's completion support.

The financial completion tests typically include: commercial operation achieved and certified; performance tests passed at stated levels; the offtake and O&M agreements in full force; insurances in place for the operating phase; required reserve accounts funded; a projected coverage ratio met on the lender's case; and no default subsisting.

Two observations.

Financial completion can lag physical completion substantially. A project can be generating and selling power for months while a reserve remains unfunded or a performance test remains to be repeated — and throughout that period the sponsor's completion guarantee is still live, which is a contingent liability with a cost even when nothing goes wrong.

The projected coverage test is the one to watch. It is the first point at which the assumptions from Series C — basis, curtailment, capture rate — are applied to a real operating asset with real data, by a lender with an incentive to be conservative. A project that cleared its sizing test on the sponsor's case in 2024 may not clear its completion test on the lender's case in 2027, and the consequence is that completion support does not release.

How Is Interest Fixed During Construction?

A separate question from the drawdown order, and one with its own timing problem.

Construction facilities are typically floating rate, and lenders normally require a hedge — an interest rate swap or cap — covering a substantial proportion of the facility. The difficulty is that the hedge has to be sized and dated against a drawdown profile that is a forecast.

Two structures address it. A forward-starting swap fixes the rate now for a notional schedule that begins later, matching the projected drawdown and term amortisation. An amortising swap with a drawdown schedule follows the projected balance throughout.

Both carry the same risk: if the project draws slower than projected — which a delayed project does — the hedge is over-notional, and the borrower is hedging debt it has not drawn. Over-hedging is an exposure, not a conservatism, and it generates a mark-to-market position that has to be settled or carried.

The practical instruction is to size the hedge against a delayed drawdown case rather than the base case, and to retain the flexibility to increase it later. The asymmetry favours it: being under-hedged costs floating exposure on the increment, which is a manageable risk; being over-hedged means paying fixed on money that was never borrowed.

The General Rule

Defer equity whenever the equity discount rate exceeds the all-in cost of construction debt.

The logic is the same one the cash sweep post applied in the other direction. There, moving cash from equity to debt destroyed value because equity discounts more heavily than debt costs. Here, moving funding from equity to debt creates value for the same reason: the project pays 6.5% plus fees to avoid equity paying 12%.

Value of deferring $1 of equity by one year
   ≈ Equity_Rate − (Debt_Rate + Commitment_Fee_Effect)
   ≈ 12.0% − 7.0%                                     ≈ 5.0%

On $62.5m of equity deferred by roughly fourteen months, that approximation gives about $3.6m — which is the net benefit computed properly above. The rule of thumb is reliable enough to run in a meeting.

Two qualifications. It assumes the lender is indifferent, which it is not — debt-first shifts risk onto the lender and may be priced for. And it assumes the equity discount rate is a genuine opportunity cost rather than a hurdle rate chosen for convenience; where a sponsor has no alternative use for the capital, the benefit of deferral is smaller than the rate implies.

The first qualification deserves a number, because it bounds the whole argument. If a lender responds to a debt-first structure by widening the construction margin, the question is how much widening consumes the $3.57m benefit. On $187.5m drawn over an average of roughly ten months of exposure, twenty-five basis points costs on the order of $390,000 — so the benefit survives a great deal of repricing before it disappears.

That asymmetry is the practical reason to ask for the structure even where it will be priced. A sponsor offered debt-first at plus twenty-five, or equity-first at the original margin, should take the first without much deliberation. It is only at a hundred basis points or more of widening, or where the lender demands additional security for the equity commitment that costs the sponsor elsewhere, that the arithmetic becomes genuinely close.

How Do You Model This in Excel?

As a monthly drawdown schedule with IDC accruing on the opening balance and fees on the undrawn commitment, and with the equity timing effect reported alongside.

The monthly loop

For each month:
   Spend(m)          = S-curve × Total_Cost

   Equity_Draw(m)    = per drawdown order
   Debt_Draw(m)      = Spend(m) − Equity_Draw(m)

   IDC(m)            = Opening_Debt(m) × Monthly_Rate
   Commitment_Fee(m) = (Facility − Opening_Debt(m)) × Monthly_Fee_Rate

   Closing_Debt(m)   = Opening_Debt(m) + Debt_Draw(m) + IDC(m)

Note that IDC accrues on the opening balance, not the closing one. Accruing on the closing balance charges interest on money drawn during the period for the whole period, which overstates IDC by roughly half a month's interest every month — a systematic error of around 4% of total IDC on a 24-month build.

The two outputs to report together

PF_TotalIDCAndFees          equity first   = $11,688,618
                            pro rata       = $13,632,812
                            debt first     = $15,577,007

PF_EquityOutflowPV          equity first   = $59,056,752
                            pro rata       = $55,265,104
                            debt first     = $51,595,361

PF_NetBenefit               pro rata       =  $1,847,454
                            debt first     =  $3,573,002

Reporting IDC alone makes equity-first look best. Reporting both makes the actual trade visible, and it is the opposite conclusion.

The circularity, kept separate

Project_Cost = Construction + IDC + Fees + DSRA + Development
Debt         = MIN( Gearing × Project_Cost , DSCR-sized )
IDC          = f(Debt drawdown profile)

This loop is genuine and it is algebraic — solvable in closed form for a given drawdown profile, or by a small number of controlled iterations. Keep it separate from the operating-phase sculpt, which as the earlier post established is not circular at all.

ℹ️ Note: Model the S-curve, not a straight line. A linear spend profile understates IDC in the second half of construction, where most spend occurs and most of the balance is outstanding. On a cosine S-curve the difference is a few percent of IDC — small, but it is a free correction.

To build the monthly drawdown, IDC and fee schedule with the three drawdown orders compared, prompt Dezzmond with your construction budget and spend curve.

What Do Sponsors and Lenders Actually Check?

• What drawdown order applies, and has the net benefit of each been computed?
• Is the sponsor's covenant good enough to support a debt-first or deferred equity structure?
• Does IDC accrue on the opening balance? Closing-balance accrual overstates it systematically.
• Is the spend curve an S-curve or a straight line?
• What does the commitment fee cost on the facility as sized, and is the facility oversized?
• Is the construction circularity solved separately from the operating sculpt?
• What happens to the availability period if the project is delayed, and what does an extension cost?

Frequently Asked Questions

What is IDC?

Interest during construction — interest accruing on drawn amounts before the project generates revenue. It is capitalised into project cost rather than expensed, funded either from the facility itself or from an interest reserve.

Why does the drawdown order matter?

Because it determines when equity is committed. Drawing debt first defers the equity cheque, and equity discounts that deferral at a higher rate than the project pays in interest — so the structure with the highest IDC is usually the one with the highest equity return.

How much is deferring equity worth?

Approximately the spread between the equity discount rate and the all-in debt cost, per year of deferral. On the worked case, deferring $62.5m by fourteen months at a 5% spread is worth about $3.6m, net of the additional IDC and fees.

What is a commitment fee?

A fee accruing on the undrawn portion of the facility. It moves in the opposite direction to IDC — drawing late means paying more in fees — and partially offsets the IDC saving from a late drawdown, by about 15% on the worked numbers.

What is the cost-to-complete test?

A certificate, required for each drawing, that the remaining available funds are sufficient to finish the works. It is forward-looking and bites before any physical milestone is missed, which makes contingency drawdown against percentage completion one of the more useful construction metrics.

What is financial completion?

A defined set of financing tests — commercial operation certified, performance tests passed, reserves funded, a projected coverage ratio met, no default — which converts the construction facility to term and releases the sponsor's completion support. It can lag physical completion by months.

Why can't every sponsor use a debt-first structure?

Because it requires the lender to accept an equity commitment instead of cash, which depends on the sponsor's credit. It is one of the few structural terms where balance sheet strength converts directly into project returns.

Closing: The Conservative Structure Is the Expensive One

Equity-first funding is described as prudent, and from the lender's point of view it is — the sponsor's money is at risk before any of the bank's, which is exactly the position a credit committee wants.

For the sponsor it is the most expensive of the three options, by about three and a half million dollars on a $250m project, and the cost is invisible in the place people usually look. The IDC line is lower under equity-first, so a model reporting financing costs alone will recommend it. The cost sits in the equity cash flow profile, fourteen months earlier, and shows up only in the IRR.

That is a general feature of this series worth restating at the end of it. Almost every structural term in project finance has a visible cost and an invisible one, and they usually point in opposite directions: the waterfall position that raises leverage and lowers real coverage; the sweep that reduces debt and destroys equity value; the lock-up that protects the lender at a cost priced in deferred distributions; and now the drawdown order whose interest saving is smaller than the timing cost it creates.

The discipline is the same in every case. Compute both sides, report them together, and let the decision be made against the net figure rather than against whichever half happens to appear in the financing cost table.

The next post takes the moment this facility ends: term conversion, what has to be true for it to happen, and the refinancing risk sitting behind a mini-perm.

Sources: Forvis Mazars — Features of a Cash Flow Waterfall in Project Finance · Edward Bodmer — Project Finance Model Funding and Sculpting Exercise · Wall Street Prep — Distinctive Features of a Project Finance Model · Synergy Consulting — Rethinking Circularity in Project Finance Models