Project Financing

Introduction

This is a long-term infrastructure; industrial project and public service based upon a non-
recourse or limited recourse financial structure where project debt and equity used to finance the
project are paid back from the cash flows generated by the project.

The people involved in a project are used to find financing deals for major construction projects
such as mining, transportation and public utility industries that may result such risks and
compensation for repayment of loan, insurance and assets in process. Its aim is to manage project
cash flows to ensure profits so that they can be distributed among multiple parties, such as
investors, lenders and other parties.

Factors to consider
These are the factors to consider while choosing the source of finance
1. Risk

Risk is an important element to consider. We must consider what will happen if we are unable to
meet the financial commitments relating to that particular source of finance. What will happen if
we are unable to meet the financial commitments of a bank loan .When it comes to choosing
suitable funding, we must strive to minimize the overall risk.

2. Cost

The cost of finance and its effect on income will play a fundamental role in our financing
decision. the overall aim is to minimise the cost of finance and maximise owners wealth.
Therefore, it is essential to consider the implications of choosing one source of funding over
another.

3. Control

Control is another factor that plays an important role when choosing a source of finance. Issuing
additional shares (equity) will result in a dilution of control among existing shareholders/owners.

Owners who do not want to lose control of their business, preferring to keep major decision-
making in their own hands, will only consider equity financing up to a certain level or may prefer
loan capital.

4. Long term versus short term borrowing

When sourcing finance, we also need to consider whether we should obtain long term or short
term funding. In many cases, it may be appropriate to match the type of funding to the nature of
the asset.

Interest rates will play a fundamental role when we are deciding our financing options. Due to
the increased risks associated with long-term borrowing, lenders will require extra as
compensation for this increased risk as their funds are tied up longer. This will be reflected in
higher interest rates.

Sources of Finance
Sources of finance are classified based on time period, ownership and control, and their source of
generation. It is can be long term, or short term.

There are various sources of finances they include:

1. Bank Loans
It is the most common source of finance.

Bank loans are not easy to obtain since it is long term. The borrower must provide a proportion
of the finance from internal resources. Merchant banks tend to demand higher rate than clearing
banks since they are normally dealing with large loans.

A construction loan mostly is used for paying construction works of the project. The loan is
released as construction progresses, in a pre- determined sequence or on the certificates raised
for the construction. Interest is paid on the funds released.

Repayment of the principal amount borrowed is made possible from the sale of the completed
property or from the proceeds of rental income by converting the construction loan into a long-
term financing.

Lending money for construction, particularly new construction, is riskier than many other types
of lending.

Lenders want to know your project will succeed, so they will take measures to evaluate the
project’s viability and their risk. .
Banks consider how invested one is on their project using two measures –

 The ratio of the loan to the value of the finished property

 The ratio of the loan amount to the total cost of developing the finished property.

The bank secures its money by using the property being developed as security to the lender or
the institution to provide personal guarantees

Currently Bank Interest rates are at 13% after Monetary Policy Committee (MPC) changed its
rates from 10 percent to 9.5 percent.

Advantages of construction loan

 They're interest-only during construction.

 They have flexible terms: To a certain extent, you'll be able to work your
loan terms around your needs for the project.

 The scrutiny provides structure which helps ensure that your project stays on
budget and schedule.

Disadvantages of a construction loan

 It is hard to qualify for Since construction loans are so flexible

 They have higher interest rates.

CONCLUSION

It will be hard so qualify for a construction loan since they have a high interest rate this
means it will take us time to repay the loan and it will most likely eat into our profits
therefore we won’t settle for a bank loan.
2. PUBLIC PRIVATE PARTNERSHIPS
In such an arrangement, the private entity undertakes to perform a public function or to
provide a service on behalf of the contracting authority and is generally liable for risks
arising from the performance of such function.

Funding in this context refers to source of money required over long term to pay PPP private
partner for the investment operating cost and maintenance cost for the project

This means that the financers involved can run the constructed five star hotel until it realizes
profit and their investment before handing over the hotel back to Technical University of
Kenya.

It involves the sharing of risk and the development of innovative, and a way of financing
over a long-term for the public and private sectors

It has been controversial due to lack of a shared understanding of what a PPP is makes the
process of evaluating whether PPPs have been successful complex.

Projects that have been built using PPP in Kenya include the Port of Mombasa Grain
Terminal that was built in 1998 and the Malindi Water Utility which was built in 1999 on a
5-year management contract

Advantages of PPP

 PPP project risks allocation enables to reduce the risk management expenditures.
 Ensure the necessary investments into public sector and more effective public resources
management.
 Ensure higher quality and timely provision of public services.
 Mostly investment projects are implemented in due terms and do not impose unforeseen
public sectors extra expenditures.
 A private entity is granted the opportunity to obtain a long-term remuneration.

PPP disadvantages:

 Infrastructure or services delivered could be expensive.

 PPP project public sector payments obligations postponed for the later periods can negatively
reflect future public sector fiscal indicators;
 PPP procurement procedure is longer and more costly in comparison with traditional public
procurement.
 They are complicated and comparatively inflexible.

CONCLUSION

PPP are complex in nature and inflexible and the project might end up being very expensive
therefore TUK will not settle for a PPP as a source of finance

3 Business Angel

A business angel is an independent individual who provides capital for the development of a
business. They help entrepreneurial businesses succeed with a business idea by investing their
own money.

This private investor not only provides money, but also are interested in exchange for an equity
stake and a place on the board.

They invest their time as well as provide connections to their larger network in order to help
guide the entrepreneur in the new business venture.

Angel investors do the following:

 They invest their own money into the project

 They make their own decisions concerning investments
 They invest according to the viability of the project, with expectations of future gains
 Their main objective is to receive a return on their investment

Conclusion

TUK will not settle for this source of finance because it normally takes longer to find a suitable
angel investor and when one is found TUK has to give up some of its shares to the business
angle. Furthermore, there is less structural support available from a business angel than from an
investing company.

4 Venture Capital

It is a form of financing that is provided by firms or funds to small, early-stage, emerging

firms that are deemed to have high growth potential, or which have demonstrated high.

Venture capital firms or funds invest in these early-stage companies in exchange for equity, or an
ownership stake, in the companies they invest in. Venture capitalists take on the risk of financing
risky start-ups in the hopes that some of the firms they support will become successful.

They exchange their capital for an equity share and involvement. Their main aim is to increase
the value of shares so that they can sell at a profit

Advantages:

 There is the potential for company expansion that would not be possible through bank
loans or other methods.
 Venture capitalists provide valuable expertise, advice and industry connections.

Disadvantages:

 Securing a venture capital deal can be a difficult process due to accounting and legal
costs,
 The company being financed must give up some ownership stake to the VC Company
investing in it.

5. Government Grants

Some government agencies and non-profit organizations offer grants to businesses based on
various conditions such as which industry you work in or where you are located.

Grants may be given to businesses that open in areas of high unemployment. Since the money is
a grant, not a loan, it doesn't have to be repaid. Not all businesses are eligible
However, companies cannot bank on grant money as your primary source of funding.

CONCLUSION

Government grants cannot be banked as the main source of funding furthermore

government entities are more risk-averse than private funders and so they do not provide
lump-sum awards. Instead, they reimburse costs which can be difficult for a small nonprofit
to grapple with due to lag times between fronting payments and waiting for
reimbursements.

6. Joint Venture

A Joint Venture is a business entity created by two or more parties, generally characterized
by shared ownership, shared returns and risks, and shared governance. Companies typically
pursue joint ventures for one of four reasons: to access a new market, particularly emerging
markets; to gain scale efficiencies by combining assets and operations; to share risk for major
investments or projects; or to access skills and capabilities.

Procedure for joint venture

i. Make a proposal

Client will make a proposal to the investor.

ii. Site Visit

The client will take the investor to the proposed site in south C .

iii. Investor makes a proposal

After visiting the site and coming up with a raw concept of the nature of development to be undertaken,
the investor makes a proposal to the client.

The proposal can also be in the form of returns and profit-sharing ratio between the parties, depending
on the agreed contribution by each side. If the land owner accepts the investor’s proposal, they can start
the formalities of drafting the main agreement, and the land owner avails copies of the title documents
for verification by the investor’s advocate.

iv. Drafting and signing the contract

Once the investor’s advocate approves the title, the advocate makes a draft copy of the joint
development contract, laying down the terms and conditions of the development and operation, and
presents it to the land owner for approval. The contract will also involve the profit sharing formula.

v. Incorporation of a joint venture company

Once the joint venture agreement has been signed, a special-purpose company is formed, with the
singular aim of fulfilling the obligations and intent of the joint venture agreement. The new company
formed should, ideally, be registered as a private limited company under the Companies Act under the
Laws of Kenya.

vi. Transfer of land to Joint Venture Company

TUK will avails to the investor’s advocate all deeds and relevant documents to facilitate the registration
of the transfer of the land

vii. Procurement of all approvals and commencement of project

By this time- the contractor and consultancy team for the project will have been formally appointed. The
investor will have the plan prepared by the project architect, taking into account the TUKs requirements,
and when ready and approved by TUK, the same will be submitted to the relevant government
authorities for approval. The terms of the joint venture agreement stipulate that all the procedures,
formalities and cost of approvals be catered for by the investor. Once the approval of the relevant
bodies has been received, work can begin and adverts placed indicating the availability of units in the
project for sale.

 Profit Sharing
On completion of the project, the built area/ houses allocated to the landowner are handed over to the
client. The formula for sharing profits will have been negotiated and agreed upon before the signing of
the agreement, which clearly spells out the terms

Problems are likely to arise in joint venture if:

 the objectives of the venture are not clear and communicated to everyone involved
 the partners have different objectives for the joint venture
 the partners bring in different levels of expertise, investment or assets into the venture
 different cultures and management styles result in poor integration and co-operation
 the partners don't provide sufficient leadership and support in the early stage