Choosing the Right Source of Finance A business needs to assess the different types of finance based on the following

criteria: Amount of money required a large amount of money is not available through some sources and the other sources of finance may not offer enough flexibility for a smaller amount. How quickly the money is needed the longer a business can spend trying to raise the money, normally the cheaper it is. However it may need the money very quickly (say if had to pay a big wage bill which if not paid would mean the factory would close down). The business would then have to accept a higher cost. The cheapest option available the cost of finance is normally measured in terms of the extra money that needs to be paid to secure the initial amount the typical cost is the interest that has to be paid on the borrowed amount. The cheapest form of money to a business comes from its trading profits. The amount of risk involved in the reason for the cash a project which has less chance of leading to a profit is deemed more risky than one that does. Potential sources of finance (especially external sources) take this into account and may not lend money to higher risk business projects, unless there is some sort of guarantee that their money will be returned. The length of time of the requirement for finance - a good entrepreneur will judge whether the finance needed is for a long-term project or short term and therefore decide what type of finance they wish to use. Short Term and Long Term Finance Short-term finance is needed to cover the day to day running of the business. It will be paid back in a short period of time, so less risky for lenders. Long-term finance tends to be spent on large projects that will pay back over a longer period of time. More risky so lenders tend to ask for some form of insurance or security if the company is unable to repay the loan. A mortgage is an example of secured long-term finance. The main types of short-term finance are:

Overdraft Suppliers credit Working capital

The main types of long-term finance that are available for to a business are:

Mortgages Bank loans Share issue

Debentures Retained profits Hire purchase

Internal and External Finance Internal finance comes from the trading of the business. External finance comes from individuals or organisations that do not trade directly with the business e.g. banks. Internal finance tends to be the cheapest form of finance since a business does not need to pay interest on the money. However it may not be able to generate the sums of money the business is looking for, especially for larger uses of finance. Examples of internal finance are:

Day to day cash from sales to customers. Money loaned from trade suppliers through extended credit. Reductions in the amount of stock held by the business. Disposal (sale) of any surplus assets no longer needed (e.g. selling a company car).

Examples of external finance are:

An overdraft from the bank. A loan from a bank or building society. The sale of new shares through a share issue.

What is Project Finance?

Project finance differs from other forms of funding primarily because it is based on the future cash flow of an enterprise that is housed in a special purpose vehicle or SPV. This is normally a company that has one specific purpose, be it a mine, industrial plant or factory. Unlike other loans, which are based on a balance sheet (the lenders income and assets), an SPV needs to start making money before it can begin repaying its loans. First, this can take years, and second, there is no guarantee the project will bring in cash unless every eventuality is looked at in the feasibility and planning stage of the project, and every risk is mitigated. The financier needs to be assured that the project can make the cash the developers and operators say it can. This is what makes a project bankable.

A large focus
By their very nature, projects are large. Some form of infrastructure needs to be built, engineers and environmental impact studies must be involved and often rights and concessions need to be secured. The loans involved in projects of this nature range anywhere from R70 million to the upper hundreds of millions, and banks will not even look at small projects asking for small amounts. There simply is no point for banks to finance small projects, explains Johan Greyling, a director at Cresco Project Finance. Banks involved in project finance will hire a team of experts with a deep understanding

of the industry in question to go through the proposal with a fine-toothed comb. This is an expensive process and whether the project is asking for R5 million or R500 million, the team needs to do the same amount of work. Its just not feasible for banks to get involved in small projects the margins of return are too low.

Sharing the risk

No financier will grant a 100% loan. Financial institutions will simply not take on the risk of a project alone. Both development finance institutions (DFIs) and commercial banks require the lender to have skin in the game in other words, some form of equity commitment. The logic behind this is simple: before the bank loan gets defaulted on, shareholders must feel the pain, says Greyling. The developers are often the only people who can ensure the projects success, which, from the banks point of view means they should also be at risk, and therefore driven to resolve any problems. Lenders will generally look to share the projects risk with the sponsors and other financial partners. It is not unusual to have multiple financiers involved in a project. Luckily however, it often just takes getting one financier on board for others to follow suit. The Industrial Development Corporation (IDC), for example, will identify other suitable international and local DFIs, commercial and merchant banks and even export credit agencies as potential participants in the deal. A commitment from one reputable financier may often serve to convince others to come on board, particularly since the risk is being shared.

Common misconceptions in Project Finance

Getting a project off the ground often seems complex to entrepreneurs. The nature and size of project finance, and the fact that it involves millions, if not hundreds of millions, of rands, makes it seem unattainable. Add to this the fact that project developers and sponsors sometimes believe that cash available to finance projects is hard to come by, and project finance seems elusive at best if not impossible to obtain. But financiers are telling a very different story. One of the Industrial Development Corporations (IDC) core principles is the development of new entrepreneurs. So why do entrepreneurs involved in project development believe that project finance is unavailable? According to Anthony Sykes from the International Project Finance Association (IPFA), there is an acute lack of bankable projects in Africa: not an acute lack of finance, but rather of projects that are worthy of being financed. Project finance is often viewed as higher risk than other finance, says Crescos Johan Greyling. This isnt really true. Yes, there are risks involved in financing a project, largely because it is years before the project can actually start making money and paying off its loans. There is also a certain amount of crystal ball gazing that needs to take place the sponsors of the project and the financiers need to predict how much money the project can make, and gear the loan accordingly. Its a very precise science. Because of this, every possible component of the project is looked at, and each risk mitigated, leaving no room for error. That makes project finance less risky than its often assumed to be but much harder to receive. For those who put together an air-tight project finance proposal, based on a solid feasibility study in which all risks are mitigated, and have a strong sponsor backing them, project finance doesnt need to be a pipe dream it can be a reality.

The Key Players in Project Finance

Entrepreneurs

Like any venture, projects are all about spotting the right opportunity at the right time. What will the next big commodity boom be? Is South Africa ready for a slew of biofuel and renewable energy projects? The entrepreneur who not only recognises the possibility of a project, but is able to put together an exciting and commercially viable project, with the risks allocated and addressed appropriately, will be able to access the holy grail of the funding world: project finance. As an entrepreneur, if you have the vision and the patience to see a project through, there is no reason why you shouldnt be successful.

Sponsors
Finding the right sponsor or sponsor group is perhaps the most important step for an entrepreneur looking to secure project finance. The project developer always needs to provide an appropriate level of own-capital to attract project finance loans from financiers. A sponsors expertise and experience will carry weight with the banks. So who are these sponsors? Essentially, they identify an opportunity and take advantage of its commercial realisation. Sponsors could be big local and international groups that sell the equipment or supply the services for big projects, be it the technology needed to put up a solar plant, or the engineers to design and build a processing plant. They benefit from projects, which is why they are always on the lookout for a good opportunity. For the entrepreneur, the individual might be small, but the sponsor group is big. Sponsors lend weight and much-needed industry experience to the idea, one of the first things financiers look for in a deal.

Financiers
Depending on the project, developers can approach development finance institutions (DFIs) such as the International Finance Corporation (IFC), which is the commercial arm of the World Bank, the Industrial Development Corporation (IDC) and the Development Bank of Southern Africa (DBSA), or commercial banks, and export credit agencies or funds.

Development Finance Institutions

DFIs are financial institutions established by governments with specific mandates to develop and promote key sectors considered to be strategically important to the overall socio-economic development objectives of various countries. These strategic sectors include agriculture, small and medium enterprises (SMEs), infrastructure, maritime, the export-oriented sector as well as capital-intensive and hightechnology industries. Many DFIs belong to global or continent-based initiatives (such as the World Bank), and will operate in other countries or across various continents.

Commercial banks
Most commercial banks have a project finance division and are extremely good at evaluating feasibility studies. Approach banks early in the project finance cycle to judge whether there is interest in your project, and which banks have an appetite for the sector you are working in.

Structuring Your Deal

The rules for project finance are the same globally, which means banks and DFIs from around the world can be involved in African and South African projects. It also means that local projects are competing globally for funds. Proposals have to be air-tight in order to receive funds. Whether a developer approaches a DFI or commercial bank for finance, there are certain criteria that must be met in order to obtain finance. Heres what financiers are looking for, and how to give them what they want.

1. Get a sponsor The first thing an entrepreneur who has recognised an opportunity needs to do is engage with a large operator in the sector to be the projects sponsor. Many emerging players encounter a barrier to entry into this field because the initiator of a project needs to be a strong player, says Charles Marais, project finance expert and a consultant at Eversheds law firm. The only way this can be circumvented is for the entrepreneur to partner with a strong sponsor. Once an entrepreneur has recognised a good idea or a gap in the market, he should find a sponsor who will benefit from the project being commissioned, he explains. Project finance is all about cash and risk. These risks can loosely be categorised into three parts: environmental risks, construction risks and operational risks. Large sponsors probably have experience in recognising and mitigating these risks, so an entrepreneur who wants to get his project banked should get the experts in. Stephen Vermaak, principal investment officer, IFC, offers another reason why entrepreneurs should partner with sponsors: The formation of partnerships between big industry players with experience and up-and-coming entrepreneurs is good for the industry as a whole because it brings new skills into the market place, but for the entrepreneur, it really is a way of accessing finance, he says. Over 50% of our financing is to existing clients. If you get finance once, chances are you will receive finance on your next project too, with less effort needed than the first time round. Partnering with a big sponsor puts you on the radar of financiers. 2. Put together an expert team Finding the right sponsor is only the first step however. According to Greyling, lenders are reliant on the project generating cash flow, which means they are interested in everything in your business, from where you are sourcing your electricity, and who your suppliers and buyers are, to the costs of the process of designing, building and finally running your project. They evaluate everything. Many entrepreneurs misjudge the costs involved in the early stage development of a project. Engineering and design costs, environmental studies and management plans, raw material procurement and negotiation, power supply, operating and logistical regimes and getting the documentation watertight are all lengthy and expensive processes. But without getting all these aspects right from the beginning, the project wont be financed, says Greyling. The best way to get your project right from the word go is to involve experts and advisors. This includes engineers, architects, consultants and lawyers. Marais agrees. It takes a team to compile a quality proposal, with different experts addressing different areas, he says. Greyling advises approaching financiers early. Show them the deal and the structure, he says. Test their interest and create an appetite for the deal, and while you are doing this, you can extract their main concerns and work on them. There is no point in approaching the banks until a proper team is in place. On the other hand, many developers dont approach professionals until late in the process because they are trying to save money, says Marais. The problem with this approach is that by that stage you either havent maintained the banks appetite because there were problems with the packaging of the deal, or poor documentation actually sets you back six months or more when the banks return your proposal for reworking. Project documents are what make a project come together because they capture the agreements that the project is based on, including operator, construction and supplier

agreements. They make projects work. If an entrepreneur really cannot afford to engage lawyers because the feasibility stage is simply too expensive, Marais suggests negotiating with the firm in question. As in other areas, fees can be negotiated and budgeted for. Some firms may even be prepared to work on risk for a portion of their fees, he says. Either way, dont skimp on your team if you want your project financed. Just as financiers share the risk of funding a project, so too does a team of experts run a higher chance of success by covering all possible eventualities. Advisors bridge the gap between a project and a bankable project. 3. Conduct an air-tight feasibility study The feasibility stage is about three things: the financial model, which highlights risk and how risks will affect servicing the projects debt, sponsor support, and an independent expert/technical report. This can take at least eight months to complete. Legal, commercial, financial structuring and engineering decisions are made during this stage based on the team doing its due diligence and extensive research. The feasibility stage of a project is expensive, explains Greyling. It takes on average eight months to complete this stage. During this time, engineers, lawyers and consultants need to be paid, and studies such as environmental impact assessments (EIAs) must be conducted.Many entrepreneurs particularly first-timers to project finance do not realise how expensive the feasibility stage can be. DFIs can be approached to help, but banks typically will only get involved once the project is proven and bankable, in other words, once the feasibility stage is complete. Never expect the financier to complete your feasibility with their due diligence, he warns. They have hundreds of proposals to work through and their interest will lie in those deals that offer the least resistance, where the team has done their work and all the banks need to do is check that the commercial viability stacks up.

Gearing
Gearing refers to the level of debt that a project can realistically afford to repay. Any uncertainty around a projects revenue line will impact the level of gearing. Take mining commodities as an example. Commodities prices are generally cyclical, explains Greyling. If the project depends on the sale of a commodity, the gearing will be adjusted accordingly and the sponsor might have to put in more equity to mitigate the risk of not being able to meet the loan repayments while commodity prices are at the bottom end of a cycle. This takes careful study and planning during the feasibility stage, because the sponsors need to be able to prove exactly how much of the commodity can be mined, at what grade, and what the markets appetite is for the commodity. The same would be true for renewable energy, manufactured goods or even telecoms services. What is the markets appetite, and how much of this appetite does the project provide for, and at what cost? The gearing of the project will be based on assumptions around these issues.

Mitigating Risks
Marais insists that properly understanding the risks involved in projects is the most important part of the feasibility study. Cash and risk, thats all a project is really about, he repeats. To understand the pitfalls of a project, research and due diligence are vital. Simply recognising the risks is not enough though. Each of those risks must be mitigated. If they are not, the project will not receive finance.

According to Greyling, project risk can generally be broken down into 16 core categories. Each of these categories should be carefully evaluated and the projects sponsors must present financiers with action plans of how each potential risk can be mitigated. This will then affect the projects bankability. Of the risks cited, the most important is probably completion risk. What can stop the project from being completed and commissioned (and therefore making money), and how can the team ensure that this does not happen? It is vital that this is addressed in the funding proposal. The whole risk mitigation and project finance process is designed to ensure cash flow, explains Marais. Once this process is complete and the project is given the green light, cash must come how and when it is expected to. If that happens, the project makes money, the lenders get their return on investment and the sponsors get their project. 4. Packaging your proposal Sponsors seldom ask someone else what is wrong with their project or proposal when they fail to receive funding, although often this would allow them to see the gaps in their plan which, once filled, might lead to a successful application. Seek advice from consultants, lawyers and financiers involved in project finance before putting together a proposal. An appealing proposal that meets project finance criteria can get you a yes first time round.

Financial Institutions Financial sector plays an indispensable role in the overall development of a country. The most important constituent of this sector is the financial institutions, which act as a conduit for the transfer of resources from net savers to net borrowers, that is, from those who spend less than their earnings to those who spend more than their earnings. The financial institutions have traditionally been the major source of long-term funds for the economy. These institutions provide a variety of financial products and services to fulfil the varied needs of the commercial sector. Besides, they provide assistance to new enterprises, small and medium firms as well as to the industries established in backward areas. Thus, they have helped in reducing regional disparities by inducing widespread industrial development. The Government of India, in order to provide adequate supply of credit to various sectors of the economy, has evolved a well developed structure of financial institutions in the country. These financial institutions can be broadly categorised into All India institutions and State level institutions, depending upon the geographical coverage of their operations. At the national level, they provide long and medium term loans at reasonable rates of interest. They subscribe to the debenture issues of companies, underwrite public issue of shares, guarantee loans and deferred payments, etc. Though, the State level institutions are mainly concerned with the development of medium and small scale enterprises, but they provide the same type of financial assistance as the

national level institutions. National Level Institutions A wide variety of financial institutions have been set up at the national level. They cater to the diverse financial requirements of the entrepreneurs. They include all India development banks like IDBI, SIDBI, IFCI Ltd, IIBI; specialised financial institutions like IVCF, ICICI Venture Funds Ltd, TFCI ; investment institutions like LIC, GIC, UTI; etc.
1. All-India Development Banks (AIDBs):- Includes those development banks which

provide institutional credit to not only large and medium enterprises but also help in promotion and development of small scale industrial units.

Industrial Development Bank of India (IDBI):- was established in July 1964 as an apex financial institution for industrial development in the country. It caters to the diversified needs of medium and large scale industries in the form of financial assistance, both direct and indirect. Direct assistance is provided by way of project loans, underwriting of and direct subscription to industrial securities, soft loans, technical refund loans, etc. While, indirect assistance is in the form of refinance facilities to industrial concerns.

Industrial Finance Corporation of India Ltd (IFCI Ltd):- was the first development finance institution set up in 1948 under the IFCI Act in order to pioneer long-term institutional credit to medium and large industries. It aims to provide financial assistance to industry by way of rupee and foreign currency loans, underwrites/subscribes the issue of stocks, shares, bonds and debentures of industrial concerns, etc. It has also diversified its activities in the field of merchant banking, syndication of loans, formulation of rehabilitation programmes, assignments relating to amalgamations and mergers, etc.

Small Industries Development Bank of India (SIDBI):- was set up by the Government of India in April 1990, as a wholly owned subsidiary of IDBI. It is the principal financial institution for promotion, financing and development of small scale industries in the economy. It aims to empower the Micro, Small and Medium Enterprises (MSME) sector with a view to contributing to the process of economic growth, employment generation and balanced regional development.

Industrial Investment Bank of India Ltd (IIBI):- was set up in 1985 under the Industrial reconstruction Bank of India Act, 1984, as the principal credit and

reconstruction agency for sick industrial units. It was converted into IIBI on March 17, 1997, as a full-fledged development financial institution. It assists industry mainly in medium and large sector through wide ranging products and services. Besides project finance, IIBI also provides short duration non-project asset-backed financing in the form of underwriting/direct subscription, deferred payment guarantees and working capital/other short-term loans to companies to meet their fund requirements.
2. Specialised Financial Institutions (SFIs):- are the institutions which have been set up to

serve the increasing financial needs of commerce and trade in the area of venture capital, credit rating and leasing, etc.

IFCI Venture Capital Funds Ltd (IVCF):- formerly known as Risk Capital & Technology Finance Corporation Ltd (RCTC), is a subsidiary of IFCI Ltd. It was promoted with the objective of broadening entrepreneurial base in the country by facilitating funding to ventures involving innovative product/process/technology. Initially, it started providing financial assistance by way of soft loans to promoters under its 'Risk Capital Scheme' . Since 1988, it also started providing finance under 'Technology Finance and Development Scheme' to projects for commercialisation of indigenous technology for new processes, products, market or services. Over the years, it has acquired great deal of experience in investing in technology-oriented projects.

ICICI Venture Funds Ltd:- formerly known as Technology Development & Information Company of India Limited (TDICI), was founded in 1988 as a joint venture with the Unit Trust of India. Subsequently, it became a fully owned subsidiary of ICICI. It is a technology venture finance company, set up to sanction project finance for new technology ventures. The industrial units assisted by it are in the fields of computer, chemicals/polymers, drugs, diagnostics and vaccines, biotechnology, environmental engineering, etc.

Tourism Finance Corporation of India Ltd. (TFCI):- is a specialised financial institution set up by the Government of India for promotion and growth of tourist industry in the country. Apart from conventional tourism projects, it provides financial assistance for non-conventional tourism projects like amusement parks, ropeways, car rental services, ferries for inland water transport, etc.

3. Investment Institutions:- are the most popular form of financial intermediaries, which

particularly catering to the needs of small savers and investors. They deploy their assets largely in marketable securities.

Life Insurance Corporation of India (LIC):- was established in 1956 as a wholly-

owned corporation of the Government of India. It was formed by the Life Insurance Corporation Act,1956 , with the objective of spreading life insurance much more widely and in particular to the rural area. It also extends assistance for development of infrastructure facilities like housing, rural electrification, water supply, sewerage, etc. In addition, it extends resource support to other financial institutions through subscription to their shares and bonds, etc. The Life Insurance Corporation of India also transacts business abroad and has offices in Fiji, Mauritius and United Kingdom . Besides the branch operations, the Corporation has established overseas subsidiaries jointly with reputed local partners in Bahrain, Nepal and Sri Lanka.

Unit Trust of India (UTI):- was set up as a body corporate under the UTI Act, 1963, with a view to encourage savings and investment. It mobilises savings of small investors through sale of units and channelises them into corporate investments mainly by way of secondary capital market operations. Thus, its primary objective is to stimulate and pool the savings of the middle and low income groups and enable them to share the benefits of the rapidly growing industrialisation in the country. In December 2002, the UTI Act, 1963 was repealed with the passage of Unit Trust of India (Transfer of Undertaking and Repeal) Act, 2002, paving the way for the bifurcation of UTI into 2 entities, UTI-I and UTI-II with effect from 1st February 2003. General Insurance Corporation of India (GIC) :- was formed in pursuance of the General Insurance Business (Nationalisation) Act, 1972(GIBNA ), for the purpose of superintending, controlling and carrying on the business of general insurance or non-life insurance. Initially, GIC had four subsidiary branches, namely, National Insurance Company Ltd , The New India Assurance Company Ltd , The Oriental Insurance Company Ltd and United India Insurance Company Ltd . But these branches were delinked from GIC in 2000 to form an association known as 'GIPSA' (General Insurance Public Sector Association).

State Level Institutions Several financial institutions have been set up at the State level which supplement the financial assistance provided by the all India institutions. They act as a catalyst for promotion of investment and industrial development in the respective States. They broadly consist of 'State financial corporations' and 'State industrial development corporations'.

State Financial Corporations (SFCs) :- are the State-level financial institutions which play a crucial role in the development of small and medium enterprises in the concerned States. They provide financial assistance in the form of term loans, direct subscription to equity/debentures, guarantees, discounting of bills of exchange and seed/ special capital, etc. SFCs have been set up with the objective of catalysing higher investment, generating greater employment and widening the ownership base of industries. They have also started providing assistance to newer types of business activities like floriculture, tissue

culture, poultry farming, commercial complexes and services related to engineering, marketing, etc. There are 18 State Financial Corporations (SFCs) in the country