Debt funding

Successful commercial activity requires the attraction of funding sources that meet the production and investment needs of the business.

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.

All investment costs must be covered by the planned cash flows in accordance with the schedule.

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.

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).

Since external resources are very often used for business development, the most important decision for any company is the right choice of a source of debt funding for investment projects. Decision-makers must analyze multiple factors and take into account the expert opinion of independent financial advisors.

Costex Corporation DBA, an international company, offers business debt funding on favorable terms.

Our finance team also advises businesses on lending, investment, marketing and more. Contact us to learn more.

Debt or equity financing: comparing opportunities

The use of debt financing for investment projects is usually considered in situations when a business is on the verge of another expansion, 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.

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.

Debt funding: advantages and disadvantages

Basically, debt financing means borrowing funds from banks, other financial institutions or companies in order to support current business activities or implement investment projects.

Debt funding takes various forms depending on specific sources and schemes, debt repayment period, collateral, etc.

The advantages of debt funding

Maintaining control over the company is considered to be the most important advantage of this approach.

Unlike equity financing, a loan does not imply the transfer of part of the business in the form of shares to the lender.

The advantages of debt funding include:

• Using the loan for almost any business purpose.
• Reduced tax pressure by treating interest as company expense.
• Minimal interference of creditors in the day-to-day activities of the business.
• Simplified procedures for obtaining funding.
• Flexible terms of debt repayment.

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.

This is fundamentally important for some entrepreneurs who strive to maintain independence above all else.

In particular, corporate control is necessary for companies that are pursuing an aggressive business strategy. For such companies, the loss of some assets in the event of default on obligations may be considered less of a problem than the loss of independence and control.

If debt financing of investment projects is carried out with careful planning and professional legal support, the risk of loss of assets for the borrower is minimal.

The second 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.

Finally, continuous debt repayment raises the credit rating of the borrowing company, which in the future will greatly simplify the business's access to debt funding and increase the financial stability of the company as a whole.

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

If we talk about the negative aspects of this type of financing, a serious disadvantage is the high cost of borrowed funds.

The company is forced to pay not only the principal amount of the loan, but also interest, fees, insurance and other expenses depending on the specific loan agreement.

Appearing as debt in the financial statements of the borrower, loans become a serious financial burden for the business for many years and restrict its commercial activities. Constant payments over a long period of time (for large investment projects, the debt repayment period reaches 15 years or more) can pose a threat to business, since market, economic and political changes for such a long period are difficult to predict.

Another problem is the complexity of the process of obtaining a large loan.

Obtaining a long-term loan, especially when it comes to large amounts of about 50 million euros or more, is accompanied by a long and complex check of the applicant by the bank.

In addition to preparing an application and a set of official documents (including financial statements), borrowers are often required to provide collateral. Real estate (factories, commercial and residential premises, land plots) and movable property (inventories, fuel, equipment, building materials, and so on) can act as collateral. Financial liabilities (loans secured by receivables) also serve as collateral.

In case of default on obligations under the loan agreement, the lender can sell the pledged assets of the debtor and return the loan, including interest.

The possibility of losing part of corporate assets represents another risk for the borrower in the long term.

Guaranteed loans can be issued under the official guarantee of government agencies, international institutions, large companies or other reputable partners. Banks use guaranteed loans in cases where the applicant's solvency is doubtful, and the company is not ready to provide sufficient assets as collateral.

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.

Highly indebted companies are viewed by potential investors as risky, which limits their funding options.



It is worth noting that debt obligations can negatively affect business growth, since a significant part of the profit goes to repaying loans. In the long term, this can affect business prospects, since the situation in the globalized market is unpredictable and, in general, extremely volatile.

Considering all of the above, many companies have to use several sources of project financing, including equity financing.

To a certain extent, the issue of shares helps to balance the sources of capital, making the company more stable and viable.

Equity financing: advantages and disadvantages

Equity financing provides for the issue of shares in order to attract investments for the implementation of large projects and support the current commercial activities of the company.

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 most important advantage of this approach is considered to be access to an alternative source of funds in conditions when bank loans for certain reasons are not available to the company.

This is especially important at the initial stage of any business as a quick source of start-up capital.

The advantages of equity financing include:

• Attraction of significant financial resources.
• Flexibility and low administrative costs due to the use of investor infrastructure.
• Ability to attract funding for complex and risky business ideas.
• Complete confidentiality of the information provided.
• Access to other forms of funding.

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.

This source of funding is considered the least risky, although the company has to pay for investors' money by losing its independence.

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 financing.

A relative advantage of this type of financing is the involvement of professional industry investors in the management of the company. Some of them can offer valuable business solutions, international contacts, new markets and new sources of capital.

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 characteristic feature of equity financing that makes it unacceptable for some entrepreneurs is the division of the company and its profits among shareholders.

This means that as the business grows, dividends will also grow, and the real cost of capital raised in this way may turn out to be significantly higher compared to lending.

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 final decision on the choice of the source of financing for the investment project is made on an individual basis, depending on the specific situation, the combination of market factors and the requirements of financial institutions to the applicant.

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.

Non-refundable financing

Sources of non-refundable financing for investment projects include subsidies and grants usually provided by national and international financial institutions (for example, subsidies from European Union funds) for the development of strategic projects in certain industries.

This funding source is rarely used.

With rational spending of budgetary funds in accordance with the terms of the agreement, the business receives many advantages:

• Improving financial stability.
• Minimum contribution of the initiator of the project.
• Rapid development of the priority line of business.

The lack of non-refundable financing through subsidies and grants is that government agencies actively intervene in the implementation of investment projects and strictly control the spending of funds, which often leads to a slowdown in the process and other complications.

Sources of debt funding for investment projects

When embarking on the implementation of the next capital-intensive project, the company will have to choose the most suitable sources of financing.

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 most cases, capital-intensive projects are implemented by large companies that have a complex corporate structure with many distributed divisions and unrelated assets. These companies have a long and successful operating history and high credit ratings that provide ample opportunities for obtaining bank financing.

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.

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.



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.

This is very important to ensure the sustainability of business in the face of political and economic instability.

Table: Sources of financing investment projects for large businesses.

Sources of funding	Description, advantages and disadvantages
Leasing	Leasing is widely used in infrastructure, industry, energy and other capital-intensive sectors where a business requires significant financial resources with a long project payback period. Leasing is a contractual relationship for the transfer of assets for temporary use with the possibility of subsequent purchase by the lessee.
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. Such loans can be issued by banks, including international development banks, as well as banking consortia in the form of a syndicated loan. Investment loans in general are characterized by high flexibility of financial conditions and ease of attracting financing, so they remain one of the most preferred sources of debt financing for investment projects.
Issue of bonds	This financing is carried out through the issuance of corporate bonds by the company in order to obtain funds for the implementation of a specific investment project. 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).
Share capital	The stock market is a valuable source of capital for the investment activities of large companies. The issue of shares allows such players to quickly raise significant funds without burdening the business with debt obligations.
Government subsidies	Budget financing of large investment projects is not a classic example of debt financing, since funds received from the state are not returned. Subsidies are provided to companies for the implementation of socially significant projects such as roads, power plants, waste processing plants.
Project finance	Project finance (PF) is a special way of financing large projects through specially created companies, SPVs. The borrowed funds are provided against the planned cash flows of the project, which is associated with additional risks for lenders. PF allows large companies to flexibly combine various instruments of banking, government or international capital.

Equity and debt sources of financing for investment projects that are worth considering for large business are listed in the table.

This list does not include funding sources for operating expenses such as short-term loans or overdrafts. It also did not cover venture capital tools relevant to startups.

International financing of large companies

Today, the commercial activities of large companies are no longer limited to one country or region.

The implementation of investment projects is often carried out with the participation of partners from many countries, which requires the use of innovative instruments for international business financing.

The main sources of financing for such projects are government institutions, commercial banks, international development banks and specialized agencies. Also, the missing financial resources can be attracted by companies entering the international capital markets.

International development banks finance significant projects at the national or international level, usually operating within a specific region (for example, Africa or Latin America).

Examples of such organizations are the Asian Infrastructure Investment Bank, the European Bank for Reconstruction and Development, the Inter-American Development Bank, etc.

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.

Commercial banks provide loans all over the world, stimulating international projects.

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).

Choosing funding sources for investment projects

Long-term financing requires a careful, balanced approach to the selection of financial instruments that are most suitable for a particular investment project.

The following are factors that a business should consider when choosing funding sources:

• 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.

• The type of company and its status. The organizational type of the company, its reputation and creditworthiness are decisive factors when choosing a source of funding for projects.

• 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.

• Purpose of attracting funding. Short-term projects and operational needs require the same financial decisions, while large long-term projects require a special approach.

• Project risks. In this context, equity financing is associated with the lowest risk, since the company does not risk losing collateral and is not tied to a strict debt repayment schedule. Debt funding is considered to be more risky.

• 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.

• 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.

• 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.

The financial team of Costex Corporation DBA is ready to provide you with advice on financing investment activities.

Debt funding in the context of capital structure

Business financing can be carried out using equity capital and borrowed funds.

“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.

The optimal capital structure should provide the lowest weighted average cost of capital.

The advantage of large businesses over SMEs is the presence of specialized departments that manage financial operations and maintain an optimal capital structure. Large companies allow themselves to attract highly qualified specialists to provide consultations on project financing.

The basis for funding a business, as a rule, is the start-up capital deposited into the company's account by various investors, which usually include the founders and owners of the company. When this capital is insufficient to carry out effective commercial activities, companies consider attracting additional sources of financing, that is, debt financing.

The cost of equity financing is considered high as investors take a high risk when buying a company's shares and expect significant dividends.

Financing a business solely through equity capital results in a higher WACC.

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.

Debt funding can be carried out both in the form of a loan and in the form of a bond issue. In both cases, the creditor gets the right to claim back his money on the terms set out in the agreement. Borrowed funds are generally considered more risky than equity financing, but for successful companies with rapid growth and good market prospects, bank lending and bonds are a very attractive option.

Total debt to equity ratio

Lenders assess the financial condition of a business by a number of indicators, among which the ratio of total debt to equity of the company occupies an important place.

The lower this ratio, the more stable the company is considered and the more attractive it is for banks.

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.

This clearly shows the opposing goals of investors and lenders. Investors strive to get maximum profit with minimum investment, attracting more borrowed funds to ensure the current activities of the company and the implementation of large investment projects.

On the other hand, lenders tend to do business with companies with sufficient investment.

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.

Cash flow to total debt ratio

The ratio of the company's cash flow to debt is another important indicator that indicates the solvency of potential borrowers.

The cash flows shown in the financial statements of the company are analyzed in the context of the total debt and losses for a certain period, allowing to draw conclusions about its sustainability.

Of course, cash flows must be considered along with other financial indicators. For example, the company's real sales for the reporting period may be record high, but cash receipts in the financial statements will look underestimated due to the active sale of goods and services on credit. Likewise, the costs of any company should be analyzed with caution, given the many nuances of using one or another financial leverage.

Be that as it may, banks and other financial institutions pay attention to the availability of funds available at any given time that can be used to pay off debt.

In general, optimization of the company's capital structure is aimed at reducing the weighted average cost of capital through the right combination of debt and equity.

If you need financing for your investment or business project, contact Costex Corporation DBA.