Project Financing in India
Project financing defined as the raising of funds required to finance an economically separable capital investment proposal in which the lenders mainly rely on the estimated cash flow from the project to service their loans.
Project financing differs from conventional financing:
- In conventional financing, cash flow from different assets and businesses are co-mingled. In project financing, cash flow from the project related assets alone are considered for assessing the repaying capacity.
- In conventional financing, end use of the borrowed funds is not strictly monitored by the lenders. In project financing, the creditors ensure proper utilization of funds and creation of assets as envisaged in the project proposal.
- In conventional financing, the creditors are not interested in monitoring the performance of the enterprise and they are interested only in their money getting repaid. Project financiers are keen to watch the performance of the enterprise and suggest/take remedial measure as and when required to ensure that the project repays the debts out of its cash generation.
Sources of finance
After the project cost is ascertained, the sources of finances available for meeting the project cost are to be analyzed and a proper combination of the different sources shall be chosen that is most suitable for the project. The various sources of finance can be divided into two categories - equity capital and debt capital (borrowed capital). Debt capital enforces upon the organisation an obligation for repayment of principal and payment of interest. Equity capital does not impose any such obligation it serves as a cushion at times when the business conditions are unfavourable leading to operational difficulties. The combination of equity and debt should be judiciously chosen, and it will vary according to the nature of the project.
The following are the main sources of project finance
- Ordinary Share – Equity shares are the source of permanent capital. Equity shareholder being the owner of the company bears the risk of ownership. They are entitled to dividend on their capital invested, only after interest obligations and dividends to preference share shareholder are paid.
- Preference Shares – Preference share bears a predetermine rate of dividend. They have priority of claim over equity share in the matter of payment of dividend. If company incurs loss in a particular year, the dividend not paid during that year is to be carried forward and is to be paid in subsequent year/years when the company earns profit.
- Debentures – Debentures are instruments for raising long term debt capital. The debenture holders are the creditors of the company. The company that has borrowed money by way of debentures has the obligation to repay interest and debt on specified dates. A company may also issue convertible debenture for mobilizing funds. Convertible debentures are those debentures that are convertible into equity shares at the option of the debenture holder.
- Bonds – A bond is more or less similar to a debenture and these two terms are frequently interchangeable. In India, there is a tendency to reserve the term 'bond' to public debt securities issues by the government and public sector undertaking.
- Bridge finance – Bridge loans are sanctioned by banks and financial institution in order to help speedy implementation of the project. In the absence of bridge loan, the project implementation may get delayed for want of sufficient funds.
- Deferred Credits - Machinery suppliers provide the facility of deferred credit, provided the credit- taker offers a bank guarantee. A project promoter wants to avail the deferred credit facilities offered by machinery supplier should approach a bank for offering guarantee for the repayment of deferred instalments to the machinery supplier.
- Unsecured loans – If there is some shortfall in the means of finance, the promoters can mobilize funds from their friends, relatives and well-wishers in the form of loan to make good the shortfall. Such loans are always unsecured i.e. the lenders cannot have any charge over the assets of the company.
- Terms loans – The terms 'Term loan' denotes long term loans offered for financing. The period of principal repayment of such long-term loans varies from 5-10 years depending upon the nature of the project. Term loans are offered by All India Financial Institutions like LIC, IDBI, UTI, ICICI etc. The term lending institutions stipulate a certain minimum contribution to be brought in by the project promoter towards meeting the project cost.
Role of Financial institutions in project Financing
Project financed by a combination of equity and debt. This is more so in respect of larger projects because of arranging for equity capital to fund the entire project may not be feasible. Equity finance is made use of during the initial stage of project implementation. This is because financial institutions must insist the project promoters to mobilize equity capital before releasing their loan component. In India, All India financial institutions (like IDBI, ICICI, and IFCI), State financial corporations and banks undertake project financing. Non-banking financing companies also do project financing, but their share stands very low. All India financial institutions and state finance institutions sometimes called development bankers.
Banks are the custodian of public funds and thus they occupy the position of trustee. Hence, it is their bounden duty that they lend money only after very careful analysis and after getting it ensured that their money land in safe hands. Development finance institutions were set up with the objective of promoting industrial development. They played a significant role in helping new and first generation entrepreneurs in setting up industrial ventures.
The lending decision is primarily governed by three conditions
- The capacity of the project to repay the loan along with interest obligations, out of its own cash generations.
- The value of security offered for the loan.
- The integrity and willingness of the borrower to repay the loan in time.
The first and foremost criterion is that the project should be self-sustaining that is it must be able to repay its obligation out of its own cash generation. If this criterion is fulfilled the many objective for which the project is set up, like creation of wealth, utilization of resources, creation of employment opportunities e.tc.
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