To maintain financial liquidity and business continuity, it is necessary to select the best funding sources that meet certain criteria in terms of cost of capital and time. Successful commercial activity requires the attraction of funding sources that meet the production and investment needs of the business. The consequences of using inappropriate funding sources can be serious (for example, a high risk of insolvency or an unfavorable change in the capital structure). the most important decision for any company is the right choice of a source of debt financing for investment projects. Decision-makers must analyze multiple factors and take into account the expert opinion of independent financial advisors.
Each of the sources of equity financing and debt financing differs in terms of receipt of funds, weighted average cost of capital (WACC) and other criteria.
Viola Funding Limited, a renowned channel island Guernsey, offers business debt funding on favorable terms and affordable rates.
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Debt or equity financing for investment projects: comparing opportunities
Currently, most large companies have access to various sources of funding, including bank loans and equity capital raised through stock exchanges. Short-term loans are best suited for financing current operations such as purchasing raw materials, supplies, fuel and equipment, paying salaries and paying off other current financial obligations. However, the choice of funding sources for long-term projects is not so obvious.
The modernization or other project, when there is clearly not enough own funds for the implementation of the project.
The borrowed funds allow the company to pay the initial and operating costs in order to later pay off the debt using the future financial flows provided by the project itself and other activities of the enterprise.
Merits and demerits of debt funding
Debt funding takes various forms depending on specific sources and schemes, debt repayment period, collateral, etc.
fundamentally, debt financing implies sourcing loans from financial institutions or banks as a way to assist implement investment projects.
The advantages of debt funding: Unlike equity financing, a loan does not imply the transfer of part of the business in the form of shares to the lender. Maintaining control over the company is considered to be the most important advantage of this approach.
The advantages of debt funding include:
1)Using the loan for almost any business purpose.
2) Reduced tax pressure by treating interest as company expense.
3) Minimal interference of creditors in the day-to-day activities of the business.
4)Simplified procedures for obtaining funding.
5)Flexible terms of debt repayment.
In particular, corporate control is necessary for companies that are pursuing an aggressive business strategy.
In this case, the ownership remains in the hands of the previous owners, so creditors can neither influence the decisions of the company’s management, nor receive any profit other than the interest and commissions established by the loan agreement.
Another recorded advantage of this type of financing can be tax optimization.
Interest payments can be recorded in the balance sheet as expenses of the company, which are not subject to taxation. Consequently, professionally organized and properly executed debt financing can reduce the tax pressure on the borrowing company.
Thus, with the implementation of subsequent capital-intensive projects, it will be possible to attract loans on more favorable terms with less interest.
Disadvantages of debt financing:
Obtaining large loans to finance investment projects can be extremely difficult for young companies that do not have a good credit rating or a long operating history at all.
Equity/debt financing for investment projects: advantages and disadvantages
This is an important source of funds, which actually represents the sale of part of the business to companies and individuals (investors) with the payment of dividends and access to decision-making.
Advantages of equity financing:
The advantages of equity financing include:
1) Attraction of significant financial resources.
2) Flexibility and low administrative costs due to the use of investor infrastructure.
3) Ability to attract funding for complex and risky business ideas.
5) Complete confidentiality of the information provided.
6) Access to other forms of funding.
The second advantage of equity financing is that companies that are actively traded on stock exchanges gain access to a wide range of investors. In addition to the obvious growth in the company’s credibility, this expands the possibilities for future business refinancing.
Equity financing is successfully used by businesses to expand, modernize, and diversify commercial activities. Unlike debt funding instruments, the company does not increase debt when issuing shares.
Having an experienced management team from among the shareholders is especially important before starting a new business, as well as during the implementation of global investment projects.
Disadvantages of equity funding:
The reluctance to share powers creates an artificial constraint on attracting equity financing, as the management of the companies strives to retain a controlling stake.
The characteristic feature of equity financing that makes it unacceptable for some entrepreneurs is the division of the company and its profits among shareholders.
In any case, financial experts recommend that companies maintain close business contacts with banks and other financial institutions in order to maintain access to multiple sources of funds.
Sources of debt financing for investment projects
Depending on the origin of funds, the sources of debt funding can be classified into public (state and supranational budgets, charitable foundations) and private. The last, broadest category includes private investors, banks, financial companies, leasing companies, and so on.
In mature markets, large businesses reap the many benefits of this robust and stable ecosystem, including very low weighted average cost of capital. Large projects usually require long-term debt financing, although corporate needs include working capital loans, debt restructuring or refinancing, equity issues, and so on.
When embarking on the implementation of the next capital-intensive project, the company will have to choose the most suitable sources of financing.
Since each investment project and line of business requires different solutions, large companies often cooperate with 5-6 banks or more, using their financial proposals to the maximum.
Usually public and reputable organizations with broad business connections, large companies also have access to financial markets, they very often implement large projects in public-private partnerships (PPPs) and can receive large subsidies.
Long-term loans: Long-term bank loans can be used to finance start-up capital, as well as for the implementation of capital-intensive projects. this includes including international development banks, as well as banking consortia in the form of a syndicated loan.
Issue of bonds: This procedure will take some time and expense, but bonds have a number of advantages over traditional bank loans (in particular, the issue of bonds does not require collateral).
Project finance: Project finance (PF) is a special way of financing large projects through specially created companies, SPVs.
International financing of large companies and enterprises
The main sources of financing for such projects are government institutions, commercial banks, international development banks and specialized agencies.
International development banks finance significant projects at the national or international level, usually operating within a specific region (for example, Africa or Latin America).
Such financial institutions usually operate with the active support of governments and carry out activities aimed at stimulating economic growth in a specific region, often through the implementation of investment projects in a limited area (for example, only infrastructure projects).
These institutions, as a rule, enjoy great authority in the financial world and can act as guarantors in the implementation of large capital-intensive projects at the global level.
Currently, the range of financial proposals of the largest commercial banks is very wide.
Giants such as BNP Paribas, Crédit Agricole, Societe Generale or Deutsche Bank play an important role in the implementation of international investment projects.
International capital markets are also sources of project financing, as many companies receive large loans through bonds and depositary receipts. Notable financial instruments include American Depositary Receipts (ADRs), Global Depositary Receipts (GDRs) and Foreign Currency Convertible Bonds (FCCB).
How to choosing funding sources for investment projects
The following are factors that a business should consider when choosing funding sources:
Financial health of the company: The stable financial position of the company determines the confidence of banks and potential investors in the business, allowing it to receive loans on favorable terms and place shares on international stock exchanges with great success.
Cost of borrowed capital: Assessment of the cost of borrowed capital should take into account the cost of raising funds and the cost of using them over a certain period.
Purpose of attracting funding: Short-term projects and operational needs require the same financial decisions, while large long-term projects require a special approach.
Flexibility of financing: It is important to think in advance about changing the terms of project financing, since long-term projects largely depend on external conditions. The more flexible and simple the terms of the loan agreement, the better for the borrowing company.
Business management: As already mentioned, the issue of shares is associated with the loss of the company’s independence, since the shareholders receive the decision-making power and a share in the company’s profits. Lenders can control the business only within the framework of the loan agreement and have little influence on the policy of the company.
Tax incentives: Since the interest paid on the company’s debt obligations is not taxed, this helps to reduce the tax burden on the business and gives the borrower some advantages when using credit funds.
Given the complex nature of large investment projects, experts generally recommend using combined funding sources to reap potential benefits and limit risks.
Viola Funding Limited is ready to provide you with advice on financing and funding of your large-scale investment projects and activities.
Debt financing in the context of funds structure
The advantage of large businesses over SMEs is the presence of specialized departments that manage financial operations and maintain an optimal capital structure.
When funds is insufficient to carry out effective commercial activities, companies consider attracting additional sources of financing, that is, debt financing.
“Capital” is considered to be the total value of assets contributed to a company from various sources to support its operations. To select the optimal source of funding, a company must balance its Weighted Average Cost of Capital (WACC) and leverage.
Borrowed funds received by the company from the lender at a fixed interest rate with a specific maturity help to implement large investment projects without the issue of new shares.
If you need financing for your investment or business project, contact VIOLA FUNDING LIMITED
A high debt-to-equity ratio indicates that a company is using too much debt with a relatively small financial base of its own. This puts lenders at high risk, which is why banks are reluctant to continue to finance such companies.
The general rule of business financing is that the more investors have invested in a company, the easier it is for that company to obtain debt funding (such as bank loans). Balancing key financial indicators is one of the secrets of commercial success.
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