Project Funding - Sources of Finance

An overview of finance sources for the project

A wide variety of funding sources are available for projects or programmes, although the options available depend on the nature of the company. Key sources are loans, equity, investors, grants/funds and private finance.

Sources of short-term project finance

Overdrafts are valuable sources of short-term finance due for repayment in less than a year. Interest is only charged when the facility is used, and the interest payments are tax-deductible. They can be arranged at short notice and are flexible in the amount borrowed at any time.

Loans generally have higher interest rates and are less flexible, as payments must be made for a pre-agreed amount and at a pre-agreed time. Loans can be repaid in stages or at the end of the loan period. The interest is also tax-deductible, and the return on the loan can exceed the interest payments. The cost of borrowing money can be compared with the return from a project by calculating the Internal Rate of Return.

Sources of long–term project finance

Sale and leaseback: Assets can be sold to a financial institution and then leased back for a specific term. This releases capital in assets, which can be used for investment, but should be offset by the rental payments and loss of capital growth should the assets increase in value.

Loan Capital Debentures

A fixed or floating charge secures some loans against a company’s assets, known as debenture loans. Debenture holders receive their interest payment before any dividend is paid to shareholders, and if the business fails, the holders will be preferential creditors.

Business Angels

These private investors invest directly in a company in exchange for an equity stake and perhaps a place on the board. They usually invest in the region of USD 10k to USD100k, and they invest to receive a capital gain; they have usually experienced entrepreneurs and can be a source of helpful knowledge for the business.

Venture Capital Venture Capitalists usually offer 100k or more to companies that other financial institutions might consider too risky. They exchange their capital for an equity share and involvement at a strategic level, often through a non-executive position on the board. Their prime aim is to increase the value of their shares so that they can sell them at a profit.

Share Capital

Share Capital is raised through the company shareholders. In exchange for their investment, they receive a share of the profits through a dividend. They may also receive a capital gain through the sale of their shares are some future date. There are two main types of shares.

Ordinary shares are held by the owners of the business, who have a right to a percentage of the company profits through dividends, which vary in value depending on performance. As company owners, they have voting rights at Annual and Extra-Ordinary General Meetings; however, they are liable should the company become insolvent and therefore accept a level of risk with their investment.

Preference shares are less risky as the holders of preference shares are not company owners. They offer a guaranteed dividend, although this may be less than that ordinary shareholders receive. As preference shareholders are not company owners, they have limited voting rights.

Retained Profits

Not all profits are distributed to shareholders: the company retains a proportion as reserves. This is usually the most significant source of equity finance, costs far less than external sources that charge interest and can be distributed as the company sees fit.

Issuing Shares

Shares can be issued through new issues or rights issues. New issues are generally made simultaneously as the company is floated on the stock market, and the capital raised is significant. The new share's price is based on project growth rates, stability, market sentiment, comparison with?similar companies and the company's capital structure. A rights issue is raising capital from existing shareholders by allowing them to buy more shares. Rights issues are cheaper and better for existing shareholders than new issues. The price is lower than the current share price, and shareholders can buy more shares, sell their rights or let the rights expire.