RAISING OF FINANCE AND PROJECT
FINANCING
Finance for a Project
in India can be raised by way of
(A) Share Capital
(B) Long‑term borrowings
(C) Short‑term borrowings
Both share capital and long‑term borrowings are used to finance
fixed assets plus the margin money required to obtain bank borrowings for
working capital. Working capital is financed mainly from bank borrowings and
from unsecured loans and deposits.
Share Capital consists of two broad categories of capital namely equity
and preference. Equity shares have a fixed par value and can be issued at par
or at a premium on the par value. Shares cannot normally be issued at a
discount. However, in exceptional circumstances issue of shares at a discount
is permitted provided (a) the shares are of a class already existing, (b) the
discount is authorised by the shareholders, and (c) the issue .is sanctioned by
the Central Government. Normally the Central Government will not sanction a
discount exceeding 10%.
The corporates are now allowed to raise resources for expansion plans.
by issuing equity shares with differential voting rights. The main advantages
of such category of shares are :
1. Equity can be raised
without diluting stake of the promoters.
2. Companies can reduce
gearing‑ratios.
3. The risk of hostile‑takeovers
is reduced to a considerable extent.
4. The passing of yield in
the form of high dividends to the investors can be ensured
The following are the general disadvantages
1. The cost of servicing
equity capital will increase.
2. Poor corporate
governance may be encouraged.
3. If issued at discount,
they may raise the equity burden.
Preference shares carry a fixed rate of dividend (which can be
cumulative). These shares carry a preferential right to be paid on winding up
of the company. Preference shares can be made convertible into equity shares.
Issue of preference is not a popular form of capital issue.
The issue of capital by companies is governed by guidelines issued by
the Securities and Exchange Board of India (SEBI) and the listing requirements
of the stock exchanges.
Apart, from equity, there can also be various forms of pseudo equity.
The most common forms are fully or partly convertible debentures and
debentures, issued with
warrants entitling the holder to subscribe for equity. There can also be an issue of non‑convertible debentures.
Term finance is mainly provided by the various All India Development
Banks (IDBI, IFCI, SIDBI, IIBI etc.), specialised financial institutions (RCTC,
TDICI, TFCI) and investment institutions (LIC, UTI and GIC). In addition, term finance is also provided by the State
financial corporations, the State industrial development corporations and
commercial banks. Debt instruments issued by companies are also subscribed for
by mutual funds and financing activities are also done by finance companies.
Term lending institutions may be categorised on the basis of their area
of operations as under:
All India financial institutions
consisting of.
§
Industrial Development Bank
of India (IDB1) ( proposed to be
converted into a Commercial Bank).
§
Industrial Finance
Corporation of India (IFCI).
§
EXIM Bank
§
National Bank for
Agriculture and Rural Development (NABARD).
§
Industrial Investment Bank
of India (HBI).
§
Tourism Finance Corporation
of India (TFCI).
§
Indian Railway Finance
Corporation (IRFC).
§
Commercial Banks.
§
Risk Capital &
Technology Finance Corporation Ltd.
§
Small Industries Development
Bank of India (SIDBI).
§
Life Insurance Corporation
(LIC)
§
General Insurance
Corporation of India (GIC) and its four subsidiaries
§
Unit Trust of India
§
Power Finance Corporation
Ltd.
§
National Housing Bank
§
Rural Electrification
Corporation Ltd.
§
Infrastructure Development
Finance Corporation
§
Housing and Urban
Development Corporation Ltd. (HUDC0)
§
Indian Renewable Energy
Development Agency Ltd. (IREDA).
The institutions like LIC & GIC may not be very much associated with
the project appraisal but lend their funds in consortium with other all India
financial institutions.
State level financial institutions consisting of :
·
State Financial Corporations
(SFCs).
·
State Industrial Development
Corporations (SIDCs).
·
Regional Rural Banks &
Co‑operative Banks.
State level institutions confine their activities within the concerned
States and generally extend financial accommodation to small and medium scale
sectors.
The role of the financial and banking institutions is not merely
confined to lending of funds. They render non fund based facilities as well
like opening of letters of credit, issue of bank guarantees, etc. Besides,
there are private investment companies involved in direct and indirect
financing of the projects and also extending lease financing.
Before implementing a new project or undertaking expansion,
diversification, modernisation or rehabilitation scheme ascertaining the cost
of project and the means of finance is one of the most important considerations.
For this purpose the Company has to prepare a feasibility study covering
various aspects of a project including its cost and means of finance. It
enables the Company to anticipate the problems likely to be encountered in the
execution of the project and places it in a better position to respond to all
the queries that may be raised by the financial
institutions and others
concerned with the project.
It constitutes a crucial step in project planning. The aggregate cost
indicates the quantum of funds needed for bringing the project into existence.
Therefore, cost of project should be fixed with great care and caution. It
forms the basis on which the ‘Means of
Finance' is worked out. The calculation of the promoter's contribution is also
done on the basis of the cost of project. Hence, all items which are necessary
for the project should be included at this stage itself. The omission ' if
subsequently detected, would have to be financed by the promoters themselves.
Although, request can be made to the financial institution for additional
assistance, but it would result in delaying of the suction leading to time and
cost overruns. Besides, it would also affect the credibility of the promoters.
The evaluation of plant and machinery should also be made with extreme
care and caution as there is a possibility of some items of plant and machinery
being not included and it is at the time of implementation of the project that
the lapse is detected and the promoter is forced to finance the omitted items
from his own resources.
Practically speaking, there is always a difference between the actual
cost and original estimated cost. Leaving aside exceptional cases, the
difference in the actual cost and the original assessed cost may be +5 per cent.
If it is so h can be taken for granted that the original exercise was done with
due care. In a small project say of the order of Rs. 1 crore. or so this
difference can be adjusted deferring certain expenses of the project which am
not necessary prior to the commencement of commercial production. Yet in the
larger sized projects say of Rs. 10 crores or more, a difference of 5‑10
per cent becomes significant so far as the absolute quantum of funds ' is
concerned. This necessarily leads to the possibility of overruns in the project
right from the beginning. Therefore it is, imperative to arrive at realistic
figure of the cost of project.
Time schedule for implementation & the project is equally important
as h has direct bearing on the cost of project. Longer the time schedule higher
will be the cost. Hence, every effort
should be made to reduce the period of implementation to the maximum
possible extent. In this direction use m be made of control charts like bar
charts, PERT and CPM techniques. It should be remembered every delay has a cog
and this will result in increase in the cost of project, which in turn will
affect the profitability of the project.
It is also important to quote realistic price of different fixed/movable
assets. The financial institutions are very well versed in assessing the cost
of any project. Hence, promoters should avoid over quoting or under quoting
while, fixing the, cost of project.
The cost of project will usually
comprise of the following items:
(i) Land and site development
(ii)
Factory building
(iii)
Plant and machinery.
(iv)
Escalation and contingencies
(v)
Other fixed assets or
miscellaneous fixed assets.
(vi)
Technical know‑how
(vii)
Interest during
construction.
(viii)
Preliminary and pre‑operative
expenses.
(ix)
Margin money for working
capital.
Having established the total cost of project, promoters should work out
the means of finance which will‑enable timely implementation of the
project. Finance will ' be available from several sources and it is for the
promoters to select the most suitable sources after taking into account all the
relevant factors.
The financial structure refers to the sources from which .the funds for
meeting the project cost can be obtained, as also the quantum which each source
will contribute towards the project cost. For this purpose it would be
advisable to keep in view the following aspects.
(i)
The structure should be
simple to operate in practice.
(ii)
The plan should have a
practical bias and should serve as a working
guideline for all project forecasts.
(iii) While deciding the structure, the environmental constraints should be kept in view. For example, the conditions prevailing in the capital market, future prospects for earnings, term‑lending institutional rules and policies in operation, government guidelines, etc.
(iv) The financial structure should have an in‑built flexibility which can take care of circumstances not envisaged initially. This is because, howsoever well devised a plan way be, the overruns, changes in the project cost and term lending institutions suggestions way necessitate a change in the financial plan originally envisaged. The promoters should ' therefore, prepare a number of alternative models on the basis of different presumptions.
(v) The financial structure should be such as to make optimum use of all available resources. As use of every resource involves costs, it is imperative that the resources are put to me in the most efficient manner.
(vi)
The availability of funds
and the period, required for raising them are important while determining the
financial structure.
Preparation of Financial Plan
In order to work out the capital structure it is necessary to prepare a
financial plan. The methodology to be followed in working out a financial plan
requires consideration, of the following important factors
(1) Debt Equity gearing
(2) Owned funds
(3) Cost of capital
(4)
Availability of finance from
various sources.
(i) Debit:
Equity gearing ‑The finance required for meeting the cost of projects, can be divided into
two categories namely, (i) owned funds i.e. capital.; and (ii) borrowed funds
i.e. loans. capital usually called 'equity', consist of equity and preference
share capital as well as retained earnings i.e. reserves. Borrowed capital also
called 'debt', consist of term loans, deterred payments, debentures, deposits
from the public, etc. The mutual relationship between debt and equity is of`
greater importance while deciding about the funding of a project.
(ii) Owned Funds ‑ Owned funds mainly comprise of
equity and preference capital. However, equity capital plays much significant
role and forms the, major chunk of owned funds. As the equity capital bears no
fixed obligation of return, it is considered to be 'high risk bearing capital'.
Dividend on such capital is payable only if the company makes sufficient
profits and has adequate disposable funds. While preference capital as is
known, carries a fixed return and may be cumulative or non‑cumulative, in
character, preference shareholders cannot expect to reap fruits of success of
the company while on the other band they may be affected by the bad performance
of the company.
Compared to equity, the borrowings we usually fixed income bearing.
Whether it is term loan or debentures, secured/unsecured – convertible/nonconvertible,
they carry a fixed obligation for the company.
Therefore, it 375 important for the company/promoters to work out
various combinations of debt‑equity for a given cost of project.
Although, theoretically to alternatives may be infinite there are certain
institutional norms which have to be reckoned while arriving at a proper or
optimum debt‑equity gearing. These norms are given in Chapter 3.
(iii) Cost of capital ‑
It includes all types of funds procured/to be procured by a company to meet the
cost of project and it includes equity and preference capital, debentures, term
loans, deposits, borrowings and retained earnings. It depends upon several
factors particularly the availability of finance. For obtaining he desired
amount of capital the company has to compensate the supplier by tying dividend
or interest, depending upon the nature of capital, i.e., owned funds or
borrowings. Hence, the cost of capital is charged periodically, payable D the
suppliers in the form of dividend or interest for hiring the capital. Normally,
every project has to be funded out of owned funds and borrowings. It will be
extremely rare to find projects that are totally self‑financed or wholly
financed out of borrowed funds. Hence, usually every project will have a mix f
owned funds and borrowings; therefore, the important question that arises in
this context is what should be the proportion of owned funds and borrowings. It
has to be the endeavour of the project planners to work out the most beneficial
structure of capital for the company that is cost effective and at the same
time meets with the requirements of financial institutions.
Therefore, it is necessary that an exercise is conducted to ascertain
the cost t different types of capital. It is fairly easy to calculate the cost
of loans/ debentures. However, a comparative analysis will have to be done
between different types of borrowings available to know the cost and
advantages/disadvantages of each type of borrowing. Another comparison will
have to be done between the cost of owned funds vis‑a‑vis borrowed
funds. In this context it may be stated that ordinarily, the cost of equity is
higher than the cost of the borrowed funds. The major reason being that the
cost of borrowed funds, i.e., interest is treated as a charge on the profits of
the company, while on the other hand cost of equity capital i.e., dividend is
paid out of the post‑tax profits of the company. The difference in
treatment is due to the prevailing income‑tax policy of the Government.
Thus the share of equity capital as one of the sources of financing the
capital cost of any project has to be determined at the project finalisation
stage, itself. While determining this share‑of equity in the financing
pattern, the following three important factors have to be considered.
(i)Debt equity ratio: Debt equity ratio is one of the most important parameters on which
reliance is placed by the financial institutions while sanctioning loans for
various projects. The effect of the D: E ratio on the means of finance is that
lower the D:E ratio, higher is the requirement of equity contribution of the
promoter and conversely, higher the D:E ratio lower is the requirement of
equity contribution.
For details refer to Chapter 3
(ii)Promoters' contribution ‑As stated earlier the debt
equity ratio determines the amount of equity or the capital to be arranged
directly or indirectly by the promoters of the project. The entire amount may
be contributed either by the promoters and their families or part of the contribution
may come from relatives and friends. The financial institutions may also permit
the promoters to introduce part of the contribution by way of interest free
unsecured loans.
For details refer to Chapter 3
(iii)Stock Exchange
guidelines: In case of listed companies or those intending to be listed, they have
to follow the guidelines issued by the Stock Exchange Division of the
Government of India from time to time. According to these guidelines certain
minimum equity has to be offered to the members of the public so that the
equity shares could be listed on the Stock Exchanges.
For every category, of capital there is a distinct source of supply in
the market. Therefore, it is necessary for the promoters to identify these sources
so that they can be approached for finance at the appropriate time. A project
will require two types of funds: ‑ one, to finance purchase of immovable
assets such as land, buildings, plant and machinery, etc., and two, for
carrying on day‑do‑day operations
i.e working capital funds.
Major Funds of Long‑ Term Finance
The
major forms of long‑term finance available are:-
(a) Rupee Term
Loans -
Mainly Development Banks,
Financial
Institutions and
Investment
Institutions. Also state
level institutions and banks.
(b) Foreign Currency - Commercial Banks,
Development
Term Loan Banks and Financial Institutions
(c) Asset
Credit/Hire - Development
Banks, Financial
Purchase/Leasing Institutions
and Finance
Companies
(d) Suppliers'
Credit - Banks
and Suppliers
(Foreign Currency)
(c) Suppliers’
Credit - Banks
in conjunction with
(Local through bill Developments
Banks and
discounting) Financial Institutions
(f) Non‑convertible - Development Banks,
Financial
debentures Institutions, Investment
Institutions and Mutual
Funds
(g) Euro
Issues/External - Foreign
Sources
Commercial Borrowing
Sources of Working Capital Finance
The sources of working capital finance are mainly the following:
§
Bank Finance
§
Commercial Paper
§
Fixed Deposits
§
Inter‑corporate
Deposits
The level and terms of bank finance and commercial papers are governed
by the current directives of the Reserve Bank of India (RBI).
The terms on which a
company can collect fixed deposits from the public are governed in the case of
finance companies by RBI and in case of non-finance companies by the Companies
Act.
Inter‑corporate deposits are outside the purview of the regulations governing acceptance of deposits. As per new Section 372A, inserted vide Companies (Amendment) Ordinance, 1999 w.e.f 31st Oct. 1998, the depositing company is subject to the limit that the aggregate value of its loan, guarantee security and investment with other bodies corporate cannot exceed 60% of its paid‑up capital and free reserves or 100% of its free reserves whichever is more. Further, in respect of rate of interest, no loan shall be made at a rate of interest lower than the prevailing bank rate of interest.
Sources for Financing Fixed Assets
The type of funds required for acquiring fixed assets have to be of
longer duration and these would normally comprise of borrowed funds and own
funds. There are several types of long‑term loans and credit. facilities
available which a company may utilise to acquire the desired fixed assets.
These are briefly explained as under. Details are given in respective Chapters.
(1) Term
Loan :-
(1) Rupee loan.‑Rupee loan is available from financial institutions and banks for
setting up new projects as, well as for expansion, modernisation or
rehabilitation of existing units. The rupee term loan can be utilised for
incurring expenditure in rupees for purchase of land, building, plant and
machinery, electric fittings, etc.
The duration of such loan varies from 5 to 10 years including a
moratorium of up to a period of 3 years. Projects costing up to Rs. 500 lakhs
are eligible for refinance from all
Projects with a cost of over Rs. 500 lakhs are considered for financing
by all
For the convenience of entrepreneurs, the financial institutions have
devised a standard application form. All projects whether in the nature of
new', expansion, diversification, modernisation or rehabilitation with a
capital cost upto 5 crores can be financed
by the financial institution
either on its own or in participation‑with State level financial
institutions and banks.
For details refer to Chapter 3 & 4
(b) Foreign Currency term
loan. ‑ Assistance in the nature of foreign currency loan is available for
incurring foreign currency expenditure towards import of plant and machinery,
for payment of remuneration and expenses in foreign currency to foreign
technicians for obtaining technical know‑how.
Foreign currency loans are sanctioned by term lending institutions and
commercial banks under the various lines of credits already procured by them
from the international markets. The liability of the borrower under the foreign
currency loan remains in the foreign currency in which the borrowing has been
made. The currency allocation is made by the lending financial institution on
the basis of the available lines of
credit and the time duration within which the entire line of credit has to be,
fully utilised.
For details refer to Chapter 10
(2) Deferred payment
guarantee (DPG) ‑ Assistance in the nature of Deferred Payment Guarantee is
available for purchase of indigenous as well as imported plant and, machinery.
Under this scheme guarantee is given by concerned bank/financial institutions
about repayment of the principal along with interest and deferred instalments.
This is a very important type of assistance particularly useful for existing
profit‑making companies who can acquire additional plant and machinery
without much loss of time. Even the
banks and financial institutions grant assistance under Deferred Payment
Guarantee more easily than term loan as there is no immediate outflow of cash.
(3) Soft loan. ‑This is available under special scheme operated
through all‑India financial institutions. Under this scheme assistance is
granted for modernisation and rehabilitation of industrial units. The loans are
extended at a lower rate of interest and assistance is also provided in respect
of promoters contribution, debt‑equity ratio, repayment period as well as
initial moratorium.
(4) Supplier's line of
credit ‑Under this scheme non‑revolving
line of credit is extended to the seller to be utilised within a stipulated
period. Assistance is provided to manufacturers for promoting sale of their
industrial equipments on deferred payment basis. While on the other hand this
credit facility can be availed of by actual users for purchase of
plant/equipment for replacement or modernisation schemes only.
(5) Debentures.‑ Long‑term funds can also
be raised through debenture with the objective of financing new undertakings,
expansion, diversification and also for augmenting the long‑term
resources of the company for working capital requirements.
(6) Leasing.‑ Leasing is a general contract between
the owner and user of the assets over a specified period of time. The asset is
purchased initially by the lessor (leasing company) and thereafter leased to
the user (lessee company) which pays a specified rent at periodical intervals.
The ownership of the asset lies with the lessor while the lessee only acquires
possession and right to use the assets subject to the agreement. Thus, leasing
is an alternative to the purchase of an asset out of own or borrowed funds.
Moreover, lease finance can be arranged much faster as compared to term loans
from financial institutions. For details refer to Chapter 18.
(7) Public
deposits ‑ Deposits from public is a valuable
source of finance particularly for well established large companies with a huge
capital base. As the amount of deposits that can he accepted by a company is
restricted to 25 per cent of the paid up share capital and free reserves,
smaller companies find this source
less attractive. Moreover, the period of deposits is restricted to a maximum of
3 years at a time. Consequently, this source can provide finance only for short
to medium term, which could be more useful for meeting working capital
requirements. In other words, public deposits as a source of finance cannot be
utilised for project financing or for buying capital goods unless the pay back period is very short or the company uses it as a means of bridge
finance to be replaced by a regular term loan.
Before accepting deposits a company has to comply with the requirements
of section 58A of the Companies Act, 1956 and Companies (Acceptance of
Deposits) Rules, 1975 that lay down the various conditions applicable in this
regard.
Own Fund
(1) Equity :‑ Promoters of a project have to involve themselves
in the financing of the project by providing adequate equity base. From the
bankers/financial institutions' point of view the level of equity proposed by
the promoters is an important indicator about the seriousness and capacity of
the promoters.
Moreover, the amount of equity that ought to
be subscribed by the promoters will also depend upon the
debt: equity norms, stock exchange regulations and the level of investment,
which will be adequate to ensure control of the company.
The total equity amount may be either contributed by the promoters themselves or they may partly raise the
equity from the public. So far as the promoters stake in the equity is concerned, it may
be raised from the directors, their relatives and friends. Equity may also be
raised from associate companies in the group who have surplus funds available
with them. Besides, equity participation may be obtained from State financial
corporation/industrial development corporations.
Another important source for equity could be the foreign collaborations.
Of course, the participation of foreign collaborators will depend upon the
terms of collaboration agreement and the investment would be subject to
approval from Government and Reserve Bank of India. Normally, the Government
has been granting approvals for equity investment by foreign collaborators as
per the prevailing policy. The equity participation by foreign collaborators
may be by way of direct payment in foreign currency or supply of technical know‑how/
plant and machinery.
Amongst the various participants in the equity, the most important group
would be the general investing public. The existence of giant corporations
would impossible but for the investment by small shareholders. In fact, it
would be mo exaggeration to say that the real foundation of the corporate
sector are the small shareholders who contribute the bulk of equity funds. The
equity capital raised from the public will depend upon several factors viz.
prevailing market conditions, investors' psychology, promoters track record,
nature of industry, government policy, listing requirements, etc.
The promoters will have to
undertake an exercise to ascertain the maximum amount that may have to
be raised by way of equity from the public after asking into account the investment
in equity by the promoters, their associates and from various sources mentioned
earlier. Besides, some equity may also be possible through private placement.
Hence, only the remaining gap will have to filled by making an issue to the
public.
(2) Preference
share:‑ Though
preference shares constitute an independent source of finance, unfortunately,
over the years preference shares have lost the ground to equity and as a result
today preference shares enjoy limited patronage. Due to fixed dividend, no
voting rights except under certain circumstances and lack of participation in
the profitability of the company, fewer shareholders are interested to invest
moneys in preference shares. However, section of the investors who prefer low
risks‑fixed income securities do invest in preference shares.
Nevertheless, as a source of finance it is of limited import and much reliance
cannot be placed on it.
Compliance with Different Laws &
Regulations
In this context it would be pertinent to note that while initiating the
process for making a public issue of equity /preference shares, the promoters
will have to comply with the requirements of different laws and regulations
including Securities Contracts (Regulation) Act, 1956, Companies Act, 1956 and
SEBI guide-lines etc., and various rules, administrative guidelines, circulars,
notifications and clarifications issued there under by the concerned
authorities from time to time.
(3) Retained earnings :‑Plough back of profits or
generated surplus constitutes one of the major sources of finance. However,
this source is available only to existing successful companies with good
internal generation. The quantum and availability of retained earnings depends
upon several factors including the market conditions, dividend distribution
policy of the company, profitability, Government policy, etc. Hence, retained
earnings as a source plays an important role
in expansion, diversification or modernisation of an existing successful
company. There are several companies who believe in financing growth through
internal generation as this enables them to further consolidate their financial
position. In fact, retained earnings play a much greater role in the financing
of working capital requirements.
Seed Capital
In consonance with the Government policy which encourages a new class of
entrepreneurs and also intends wider dispersal of ownership and control of
manufacturing units, a special scheme to supplement the resource & of an
entrepreneur has been introduced by the Government. Assistance under this
scheme is available in the nature of seed capital which is normally given by way of long term interest free loan. Seed capital assistance is provided to small
as well as medium scale units promoted by eligible entrepreneurs.
Government subsidies
Subsidies extended by the Central as well as State Government form a
very important type of funds available to a company for implementing its
project. Subsidies may be available in the nature of outright cash grant or
long‑term interest free loan. In fact, while finalising the mean of
finance, Government subsidy forms an important source having a vital bearing on
the implementation of many a project.
Objective of this Book
The objective of this, Book is to provide every information on loan
schemes and facilities available from financial and banking institutions,
procedure and precautions to be taken while making loan applications, charging
of securities and execution of documents and agreements for this purpose.