UNIT 6

PROJECT FINANCING
There are two major types of project financing: equity and debt financing.

1. Loan/ debt financing

• Debt financing means when a business owner, in
order to raise finance, borrows money from some
other source, such as a bank.
• The business owner has to pay back this loan or
debt within a pre-determined time period along
with the interest incurred on it.
• The lender has no ownership rights in the
borrower's company.
• Debt financing can be both, short term as well as
long term.
 Debt cont…
There are many sources for debt financing:
• banks,
• savings and loans,
• commercial finance companies, and the microfinance institutions. State
and local governments have developed many programs in recent years to
encourage the growth of small businesses in recognition of their positive
effects on the economy.
• Family members, friends, and farmer associates are all potential sources,
especially when capital requirements are smaller. Traditionally, banks
have been the major source of small business funding. Their principal
role has been as a short-term lender offering demand loans, seasonal
lines of credit, and single-purpose loans for machinery and equipment.
• In addition to equity considerations, lenders commonly require the
borrower’s personal guarantees in case of default. This ensures that the
borrower has a sufficient personal interest at stake to give paramount
attention to the business. For most borrowers this is a burden, but also a
necessity.
2. Equity financing
• Equity financing means when a business owner, in
order to raise finance, sells a part of the business to
another party, such as venture capitalists or
investors.
• Under equity financing, the financier has ownership
rights equivalent to the investment made by him in
the business, or in accordance with the terms and
conditions set between him and the business owner.
• This is the main difference between debt financing
and equity financing.
• In equity financing, the financier has a say in the
functioning of the business as well.
 The basic differences between debt financing &
Equity financing
• Process: Procedure of raising money through debt
financing is easier, than raising money through equity
financing.
• Ownership Rights: In debt financing, the business
owner has full control and ownership of the business.
In equity financing, the investor or the venture
capitalist has ownership rights.
• Rights over Profit: In debt financing, the lenders only
have a right over the principal loan and the interest
incurred on it. They have no rights over the profits or
revenues generated by the business.
 D/ce cont…

• Ease of doing Business: In debt financing, decisions

and rights regarding running the business, solely lie
with the owner.
• Whereas in equity financing, the shareholders and
investors have to be updated and consulted about
the business regularly.
• So, it is easier to do business with debt financing,
than with equity financing.
 Advantages of Debt Compared To Equity

• Debt does not dilute the owner's ownership interest in the company.
• A lender is entitled only to repayment of the agreed-upon principal of
the loan plus interest, and has no direct claim on future profits of the
business.
• Except in the case of variable rate loans, principal and interest
obligations are known amounts which can be forecasted and planned
for.
• Interest on the debt can be deducted on the company's tax return,
lowering the actual cost of the loan to the company.
• Raising debt capital is less complicated because the company is not
required to comply with state and federal securities laws and
regulations.
• The company is not required to send periodic mailings to large
number of investors, hold periodic meetings of shareholders, and
seek the vote of shareholders before taking certain actions.
 Disadvantages of Debt Compared To Equity

• Unlike equity, debt must at some point be

repaid.
• High interest costs during difficult financial
periods can increase the risk of insolvency.
• Cash flow is required for both principal and
interest payments and must be budgeted for.
• The larger a company's debt-equity ratio, the
more risky the company is considered by
lenders and investors. Accordingly, a business
is limited as to the amount of debt it can carry.
Use more equity when
• The corporate tax rate applicable to the firm is negligible.
• Business risk exposure is high.
• Intensity of control is not an important issue.
• The assets of the firm are mostly intangible.
• The firm has many valuable growth options.
Use more debt when
• The corporate tax rate applicable to the firm is high.
• Business risk exposure is low.
• Intensity of control is an issue.
• The assets of the firm are mostly tangible.
• The firm has few growth options.
 After comparing debt financing vs. equity financing, it can be
concluded that both have their pros and cons.
 business owner who wants full authority over the business, should
choose debt financing .While an owner who is willing to share his
risks and profits should adopt for equity financing
 Leasing

• Lease is an agreement between two parties

whereby one party allows the other to use his/her 
property for a certain period of time in exchange
for a periodic fee.
• The property covered in a lease is usually 
real estate or equipment such as an automobile or
machinery.
• There are two main kinds of leases.
– A capital lease is long-term and ownership of the asset
transfers to the lessee at the end of the lease.
– An operating lease, on the other hand, is short-term and
the lessor retains all rights of ownership at all times.
Elements of Leasing
• Leasing is one of the important and popular parts of asset
based finance. It consists of the following essential elements.
• Parties: These are essentially two parties to a contract of
lease financing, namely the owner and user of the assets.
• Leaser: Leaser is the owner of the assets that are being
leased. Leasers may be individual partnership, joint stock
companies, corporation or financial institutions.
• Lease: Lease is the receiver of the service of the assets under
a lease contract. Lease assets may be firms or companies.
• Lease broker: Lease broker is an agent in between the leaser
(owner) and lessee. He acts as an intermediary in arranging
the lease deals.
• Lease assets: The lease assets may be plant, machinery,
equipments, land, automobile, factory, building etc.
Advantages of Leasing
– Balanced Cash Outflow
– Quality Assets
– Better Usage of Capital
– Tax Benefit
– Low Capital Expenditure
– No Risk Of Obsolescence
– Termination Rights
Disadvantages:
• The lessee gets only the right to use the asset.
• The lessee cannot make alterations or improvements in the
asset without the prior approval of the lessor. The lessor may
also put some restrictions on the lessee.
• The lessee has to pay lease rentals on a regular basis to the
lessor.
Thanks
a
Lot !!