Debt, equity or is there another way?

Those in the property development, mining and exploration or infrastructure sectors are faced with the perennial question of how best to fund projects to facilitate growth, manage cashflow, minimise costs and maximise profits.

The usual choices are debt, equity or a hybrid of both and the choices come in and out of fashion depending on market cycles and economic conditions. Fashion, however, is never the best dictator of business wisdom.

Debt can fall into two categories. An exploration company or a property developer can decide to borrow from an organisation, usually an investment bank, that has capital to lend in exchange for the repayment of interest and, at some stage, the principal amount of capital borrowed.

The other type of debt is when that same exploration company or property development company decides to issue its own debt instruments in the form of unsecured notes or debentures in exchange for capital. Investors are rewarded with regular interest or income payments and eventually get their capital back when the issuing company’s project is complete and they achieve a capital gain or profit.

Finally, your company can issue equity in the form of shares to investors who will, in turn, own a piece of your company and receive the benefit of capital growth via a higher share price and/or income as dividends.

Each alternative funding channel comes with its unique risks and rewards for the capital raiser.

A straight loan, unless secured with a mortgage over assets, allows you to keep the provider of the capital at arms length. So long as you honour interest repayments on time, pay fees and pay back the principal when required, the lender does not have a great deal of control over the day-to-day operations of your company or its projects.

Of course, many loans come with conditions or covenants and, the more risky your venture, the more conditions you can expect a lender to require. For example, let’s say you borrow $10 million from a lender to secure land for a commercial development. If there are no conditions or covenants you can immediately go and borrow another $10 million from another lender.

However, the first lender could set a debt restriction based on the risk profile of your business. If they calculated that you could afford an interest repayment of, say, 7 per cent on the $10 million but would be stretched if you borrowed more, they would apply a covenant that would allow them to withdraw their finance if you took an additional loan with another lender.

If the lender has only supplied 60 or 70 per cent of the capital required such a covenant could make it impossible to fully finance the project. You’d need to have healthy reserves to make up any shortfall and keep your cashflow healthy.

The creation and distribution of your own debt instruments to willing investors involves a higher level of regulatory scrutiny than borrowing money from a commercial or investment bank.

You do get to set your own interest rate but investors will only be attracted to a rate that is more competitive than currently on offer from more “secure” sources. This may mean that the “cost” is higher than borrowing but you do get to set the terms and conditions including what you can and cannot use the investors’ funds for.

Issuing shares in your company can, of course, result in a substantial inflow of funds. It also dilutes your ownership and control of the business. Going down the equity raising road also involves making decisions, depending on the size of your enterprise, about whether or not to list as a public company. That is a very big topic in and of itself which we may return to at another time.

What I want to look at now is the question of whether there might be another way to raise funds required to finance a major project. Acuity Funding’s 100 per cent funding facility is such a solution and it is unique to Acuity. This facility has initially been designed for property developers but it is an example of the innovative approach to financing that Acuity endeavours to provide all our clients.

So how does it work? It allows property developers to provide purchasers with 100 per cent finance. We secure 80 per cent of the purchase price from a mainstream lender for an interest rate of less than 3 per cent pa.

The remaining 20 per cent is financed through the Acuity Funding Lending Trust (AFLT), delivered to purchasers at a rate of 10 per cent pa. The total rate works out to be less than 4 per cent. The developer, as underwriter of the AFLT receives a return equal to around 7 per cent per annum paid monthly in arrears.

The loan is secured via a charge over the property. The interest rate is fixed for three years and then pegged at the Reserve Bank cash rate.

If you’d like to learn more about our innovate approach to finance, please get in touch with me to arrange a chat on 02 9484 0609.

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