Module III:

Financing

PROJECT FINANCE
What is Project Finance

Project financing refers to a financing in which lenders to a project look primarily to the cash flow and assets of that project as the source of payment of their loans.

CAPITAL

Capital is any form of wealth employed to produce more wealth.

Capital required by entrepreneur

FIXED CAPITAL To purchase Permanent Assets Land Building Equipments WORKING CAPITAL To support normal short operations Inventory Pay bills Pay wages and salaries GROWTH CAPITAL To support business expansion

Types of funds available

DEBT

EQUITY

What are the different sources of project financing available?

Internal Sources External Sources

Potential sources of project financing

A. Internal funds B. Private sector: 1. commercial banks 2. development corporations 3. equipment vendors/ subsidiary finance companies 4. owners capital (equity) C. Governmental sector: grants/ earmarked capital from governmental programmes

Sources of Internal Funds

Personal savings Friends and family members Angels and venture capital Partners Public Stock Sale : IPO, FPO

Sources of Finance

Business Growth

Internal Sources of Finance and Growth

Organic growth growth generated through the development and expansion of the business itself. Can be achieved through: Generating increasing sales increasing revenue to impact on overall profit levels Use of retained profit used to reinvest in the business Sale of assets can be a double edged sword reduces capacity?

External Sources of Finance

Long Term may be paid back after many years or not at all! Short Term used to cover fluctuations in cash flow Inorganic Growth growth generated by acquisition

The existence of capital markets enable firms to raise long term loans and share capital.

Long Term
Shares (Shareholders are part owners of a company)
Ordinary Shares (Equities):
Ordinary shareholders have voting rights Dividend can vary Last to be paid back in event of collapse Share price varies with trade on stock exchange

Preference Shares:
Paid before ordinary shareholders Fixed rate of return Cumulative preference shareholders have right to dividend carried over to next year in event of non-payment

New Share Issues arranged by merchant or investment banks Rights Issue existing shareholders given right to buy new shares at discounted rate Bonus or Scrip Issue change to the share structure increases number of shares and reduces value but market capitalisation stays the same

Long term
Loans (Represent creditors to the company not owners)
Debentures fixed rate of return, first to be paid Bank loans and mortgages suitable for small to medium sized firms where property or some other asset acts as security for the loan Merchant or Investment Banks act on behalf of clients to organise and underwrite raising finance Government/EU may offer loans in certain circumstances
Grants

Short Term
Bank loans necessity of paying interest on the payment, repayment periods from 1 year upwards but generally no longer than 5 or 10 years at most Overdraft facilities the right to be able to withdraw funds you do not currently have Provides flexibility for a firm Interest only paid on the amount overdrawn Overdraft limit the maximum amount allowed to be drawn - the firm does not have to use all of this limit Trade credit Careful management of trade credit can help ease cash flow usually between 28 and 90 days to pay Factoring the sale of debt to a specialist firm who secures payment and charges a commission for the service. Leasing provides the opportunity to secure the use of capital without ownership effectively a hire agreement

'Inorganic Growth'
Acquisitions The necessity of financing external inorganic growth
Merger:
firms agree to join together both may retain some form of identity

Takeover:
One firm secures control of the other, the firm taken over may lose its identity
Safeway subject to a 3 billion takeover by Morrisons. Securing the 3 billion necessary is a specialist job.

Institutional Finance to Entrepreneurs

Purpose Start new venture Modernize Diversify Rehabilitation

Institutions assisting Entrepreneurs

Small Scale Unit National small Industries corporation (NSIC) Small Industries Development Orgzn.(SIDO) Khadi Village Industries Commission(KVIC) Handloom Board Silk Board

Institutions assisting Entrepreneurs( cont.)

Medium and Large scale unit Industrial finance corporation of India(IFCI) State industrial development corporation (SIDC) ICICI bank, IDBI bank, SIDBI.

Services of SIDO
Technical resource centre Consultancy Marketing support Vendor development Buyer seller meet Quality/ Technical up gradation Training facility EDP, MDP, Skill development

Schemes of NSIC
Bank credit facilitation Export credit insurance Performance & credit rating Raw materials assistance Bills discounting Government purchase Exhibitions

National Institute for Entrepreneurship and Small Business Development (NIESBUD)

Evolving effective training strategies and methodology Standardizing model syllabi for training various target groups Developing training aids, manuals and tools Facilitating and supporting Central / State/ Other agencies in organizing entrepreneurship development programmes Conducting training programmes for promoters, trainers and entrepreneurs Undertaking research and exchange experiences globally in development and growth of entrepreneurship.

Business Angels

Business Angels
Individuals looking for investment opportunities Generally small sums Could be an individual or a small group Generally have some say in the running of the company

Venture Capital

What is VC?
Investment in High risk projects High return potential projects Equity related instruments

Venture Capital
Venture capital finance is often thought of as the early stage financing of new young enterprises seeking to grow rapidly

Venture Capital
Pooling of capital in the form of limited companies Venture Capital Companies Looking for investment opportunities in fast growing businesses or businesses with highly rated prospects May also buy out firms in administration who are going concerns May also provide advice, contacts and experience

NATURE OF VC

INVESTORS IN VC Wealthy partners Pension funds Other institutions Foreign Investors

PROVIDE FUNDS

MANAGED BY VC FIRM

GAIN RETURN FEES

Objective of VC

To generate long term capital appreciation through debt and equity investment.

Venture capitalist VS Banker

VC Equity participation Participation in management Banker Lends money No involvement in management Keeps collateral

The Role of the VC

Board involvement Management recruitment Future capital raising Access to business network Strategy development Patience!

What Do VCs Want to See?

The Nine (9) P's 1. Proposal 2. Project 3. Proponent 6. Privileges 7. Payback 8. Promotion

4. Product
5. Pricing

9. Paperwork

Investment Stages
Most VCs have a preference for a particular investment stage.
Five Stages:
Seed Start-up Early Expansion Bridge

Stage/Characteristic
Stage Seed Characteristics - Founder(s) only - No product - No customers - Primary risk: R&D
- Mgmt. team incomplete - No revenues - Limited customer interest - Some capital invested - Primary risk: market accept.

Start-Up

Stage/Characteristic
Stage
Early Expansion

Characteristics
- Most of team in place - Limited revenues - Not profitable - Primary risk:execution - Meaningful revenues - Achieving profitability - Growing customer base - Primary risk: competition

Stage/Characteristic
Stage
Bridge

Characteristics
- Significant revenues - Profitable - Industry player - IPO in 6-12 months - Risk much lower

VC investment & exit

Promoters with Project

Initial Meetings
Venture Capitalist with Funds

Prelimnary Project Review by Venture Capitalist

Term Sheet Signed by Venture Capitalist & Promoters

Due Diligence Review of Project

Promoters

Divestment & Exit from Project

Mentoring & Monitoring of Project

Investment made by Venture Capitalist in Project

Legal Documents /Agreement Signed

Venture Capitalist

What a project must have

Potential for high growth High upside potential Potential for extraordinary returns to investor Exit route plan