Project Financing is the activity of raising funds from the market, required to finance an investment proposal. Lenders primarily rely on the estimated cash flow or potential earning capacity of the project to service their loan. There are several means of finance which are used to meet the cost of the project, the following means of finance may be available –
- Share capital
- Term Loan
- Debenture capital
- Deferred credit
- Incentive sources or Government Subsidies
- Suppliers line of credit
- Unsecured loans and deposits
- Leasing and Hire Purchase
Means of Project Financing –
(1) SHARE CAPITAL
It is the capital raised by a company by issue of shares. It may take two forms –
Equity share capital – It refers to the shared held by the owners of the business. They enjoy the rewards and bear the risks of ownership of the business. Equity share holders have a voting right but they are paid dividend only after paying dividend to preference shareholders. Dividend on equity shares depends upon the amount of profits and financial position of the business.
Preference share capital – It refers to the shares held by the investors who are not owners of the business. Preference shareholders do not have any voting rights but are they receive dividend at a fixed rate and before equity share holders.
(2) TERM LOAN – Term loans are provided by Financial Institutions and Commercial banks. It represents secured borrowings for financing new projects as well as expansion, modification, renovation schemes.
It can be of two types –
Rupee term loans – They are given for financing land, building, plant & machinery etc.
Foreign currency term loan –They are given to meet foreign currency expenses towards import of machinery, equipment and technology.
(3) DEBENTURE CAPITAL – Debenture capital is a financial instrument for raising long term debt capital. It may be convertible or Non convertible.
Non-convertible debentures are straight debt instrument carrying a fixed rate and have a maturity period of 5-9 years. If interest is accumulated it has to be paid by the company by liquidation of its assets. It is an economical method of raising funds. Debenture holders do not have any voting rights and there is no dilution of ownership.
Convertible debentures are convertible wholly or partly into equity shares after a fixed period of time.
(4) LEASE FINANCING – It is a contract in which the owner of the asset (lessor) gives right to use an asset to the user (lessee) for an agreed period of time in return of consideration in form of periodic payments called lease rentals. It is used for expansion projects, since repayment can be done immediately through cash generated from existing facilities. It is a popular method of Project financing for large machinery, airplane, ships, property etc.
(5) UNSECURED LOANS – In case of shortage of funds, the promoter of the business may mobilise funds from family, friend and relatives in form of unsecured loans to meet such shortage. Lenders may or may not receive any interest on the amount lend and have no control over management and decision making. In this method of Project Financing the borrower does not have to keep any collateral for the loan therefore unsecured loans are perceived as less risky.
(6) BRIDGE LOANS/FINANCE – These are temporary loans provided by commercial banks to promoters of a business for arranging capital cost of a project. These loans are sanctioned by banks and financial institutions to help promoters in speedy development of a project, in its absence projects may be delayed due to insufficient funds.
(7) PUBLIC DEPOSITS – It refers to funds mobilized from the public and shareholders. These deposits can be taken for a minimum period of 6 months and maximum period of 36 months. The government of India has fixed the maximum amount of deposit at 25% of the paid up share capital and free resources of the company. Only a public limited company is allowed to accept deposits from public and a private company cannot do so, however private companies can raise deposits up to 25% of the share capital from friends, family and relatives.
(8) DEFERRED CREDIT – At times suppliers of plant and machinery offer a deferred payment facility under which payment of plant and machinery can be made after a certain period of time as agreed upon by the buyer and seller at the time of purchase. In order to get deferred credit a person has to furnish Bank guarantee and may even have to mortgage certain assets.
(9) INCENTIVE SOURCES – The Government and its agencies may provide financial support incentive to certain types of promoters for setting up industrial units in certain location. It may take form of –
- Seed capital assistance
- Capital subsidies
- Tax deferment