Session 3 Basics Of Project Finance Equity Debt

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Mona Iyer CEPT University

Session Outline • Means and Sources of financing – Equity – Debt – Guarantees – Grant/subsidy •

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Equity

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Means of Financing

– In a project financing, the cash or assets contributed by the sponsors. – – In accounting, the difference between total assets and total liabilities. – – Equity finance is difficult to attract, specially in initial stages of project as the risk is high and returns uncertain •

Means of Financing Equity

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– Equity investors are last in the priority of repayment – Lenders look at equity very critically for following reasons : • Lenders want the investors in a position that they cannot walk away easily from the project! They must have enough stake to motivate them to see the project through • • The more burden the debt component puts on project, the greater the lenders risk • •

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(unless sometimes guarantees are provided by very creditworthy guarantors)

Means of Financing Debt

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– Money, owed by one person to another – Commonly called loan ! – The obligation to repay an agreed amount of money •

Means of Financing Subordinated debts/loans (Mezzanine finance) – Quasi-equity, senior to equity and junior to senior debts

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– Often used by sponsor to provide capital to a project which will support senior borrowings from third party lenders •

– Can be advanced by the investor as part of its original investment on project – •

Means of Financing Subordinated debts/loans (Mezzanine finance)

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– The possible sponsors for such loans are • one of the owners (equity holders in the project), • user anxious to get the project operational, or • government interested in getting the project done and is not allowed to take equity position in a project for policy reasons – – Subordinated loan is usually considered as equity by lenders for purpose of computing the proportion of equity and debt –

Means of Financing Senior Debts

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– Debt with the highest ranking for repayment, security, or action – Borrowings from commercial bank lenders – Unsecured Debts • No security except the creditworthiness of the borrower • Project tend to be new enterprises and have no operating histories, lenders rely upon the reputation of project partners • Industry specialist or project financing specialist hired by commercial banks as they are traditional balance sheet lenders • •

Means of Financing •

Senior Debts – Secured Debts • Assets are required to secure the debtcollateral, guarantees by govt. etc • Senior lenders may hold security interest (first right) in key project assets • Security trustee appointed to act on behalf of all secured lenders in case of multiple secured lenders – Distributes the debt service in order of priority.

• Recourse: In the event a project cannot service the financing or achieve completion, the financiers have recourse to either cash from the sponsor or other non–project security. • Non-recourse: The lenders rely on the project's cash flows and security over the project vehicle's assets as the only means to repay debt service. • Risk Premium: The reward for holding a risky investment rather than a riskfree one. • Royalty: A share of revenue or cash flow to the government or grantor of the concession or license. Compensation (i.e., royalty fees) for the use of intellectual property belonging to another party, usually calculated as a percentage of sales. • Collateral: Assets pledged as security under a loan to assure repayment of debt obligations. • •

Sources of Equity •

Equity -Primary source of investment – Promoter’s equity/ Equity Capital – Promoters who launch the project • These may include Indian, Foreign, both, NRIs, Overseas Corporate bodies, investment banks

– Finance raised from public/ capital market. • • • •

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Preference capital/shares with fixed dividend rates Bonds and debentures Maturity period, rate of interest, tax exemption Can also be called as tradable debt!!

Sources of Debt Debt

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– Institutional Borrowings • Multilateral/Bilateral Development Banks • Development Banks likes ICICI, IDBI • Investment Institutions like UTI, LIC, VC funds, Pension funds • Infrastructure finance institutions IL&FS, IDFC

– commercial borrowings • • • • •

Commercial Banks Upto 35% of project cost Limitation to individual clients, sector, country Usually 15-22% interest rate per annum

Sources of Financing – Sovereign Guarantees Credit enhancement of Infrastructure project Increases comfort level of lenders State/Central Govt. IDFC Extensive use may lead to fiscal stress of Govt. RBI stipulation – sovereign guarantees to be issued by govt. as per SDP • Guarantees by commercial banks (initial charge 3% and annual commission 1.6 % • • • • •

Sources of Financing •

Grants/Subsidies

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– Are provided in those projects which are usually not financially viable or sustainable with only commercial funding. – – Grant/subsidies usually given for projects that have high economic or environmental impacts. For example, health, sanitation, environmental protection and other similar projects. – – Often used for promoting new technology and institutional development. – – In most cases, these are public infrastructures. – – General Sources: Government, multilateral of bilateral donor agencies, international agencies , Foreign aids and donations etc.

– Venture Capital: Risk capital extended to start–up or small going concerns. – Credit: Granting of goods, services, or money in return for a promise of future payment. Most credit is accompanied by an interest charge, which usually makes the future payment greater than an immediate payment would have been. – Multilateral Agency: An institution organized by a group of countries to promote development (e.g., the World Bank, the IFC, and the Inter-American Development Bank). – Bilateral Agency : An institution established by one country to promote trade with other countries, such as an exportimport agency or an export credit agency (ECA). JBIC (Japan), US EXIM (USA) –

– Development Bank: A lending agency that provides funds to encourage the creation or expansion of productive facilities in developing countries. •

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