FINANCING DEVELOPMENT PROJECTS in kenya.pptx

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1. FINANCING DEVELOPMENT PROJECTS Dr. Kiplimo Sirma PhD Kabarak University

2. In the previous lecture we learned about the concept of project financing. We also mentioned the concept of Public-Private Partnerships (PPPs), special purpose vehicle and Risk Management in projects. In this lecture, we are going to introduce you to financing development Projects, we shall also learn venture capital, the instruments used in venture capital and its characteristics. Introduction

3. Development projects refer to a special kind of investment. The term connotes purposefulness, some minimum size, specific location, the introduction of something qualitatively new, the expectation that a sequence of further development moves will be set in motion. If they are in the public sector, development projects may additionally be defined as those units or aggregates of public investments that however, small, still evoke direct involvement by high usually the highest political authorities. Development projects, then , are privileged particles of the development process, and the Defining Development Projects

4. feeling that their behaviour warrants watching at close range lead to the assessment to see how they are improving the living standards of the people. Development projects therefore are those projects which are undertaken to improve the live of the people. These may include: Basic industrial projects, irrigation projects to enhance agricultural activities, electric power for transmission and distribution of power, telecommunication projects to enhance communication in the country, and transportation. Defining Development Projects cont….

5. Venture capital refers to a form of “risk capital”. It is invested in a project where there is a substantial element of risk relating to the future creation of profits and cash flows. Risk capital is invested as shares (equity) rather than as a loan and the investor requires a higher rate of return to compensate him for his risk. The main sources of venture capital are venture capital firms and business angels i.e. private investors. The attributes that both venture capital firms and business angels look for in potential project investments are often the same or similar. What is Venture Capital?

6. Venture capital provides long-term, committed share capital, to help unquoted companies grow and succeed. If an entrepreneur is looking to start-up , expand, buy-into a business, buy-out a business in which he works, turn around or revitalize a company, venture capital could help to do this. Obtaining venture capital is substantially different from raising debt or loan from a lender. Lenders have a legal right to interest on a loan and repayment of the capital, irrespective of the success or failure of a business. Venture capital is invested in exchange for an equity stake in the business. As a shareholder, the venture capitalist’s return is dependent on the growth and profitability of the business. This return is generally earned when the venture capitalist exits by selling its share holdings when the business is sold to another owner. What is Venture Capital?

7. Venture capitalists prefer to invest in ‘ entrepreneurial businesses’ This does not necessarily mean small or new businesses. Rather, it is more about the investment’s aspirations and potential for growth, rather than by current size. Such businesses are aiming to grow rapidly to a significant size. As a rule of thumb, unless a business can offer the prospect of significant turn over growth within five years, it is unlikely to be of interest to a venture capital firm. Businesses attractive to venture capitalists

8. Venture capital investors are only interested in companies with high growth prospects, which are managed by experienced and ambitious teams who are capable of turning their business plan into reality. Businesses attractive to venture capitalists cont…

9. Venture capital firms usually look to retain their investment for between three and seven years or more. The term of investment is often linked to the growth profile of businesses, where the business performance can be improved quicker and easier, are often sold sooner than investments in early stages or technology companies where it takes time to develop the business model. How long the venture capitalist invest in a business

10. Just as management teams compete for finance, so do venture firms. They raise their funds from sources. To obtain their funds, venture capital firms have to demonstrate a good track record and the prospect of producing returns greater than can be achieved through fixed interest or quoted equity investments. Most Kenyan and UK venture capital firms raise their funds for investment from external sources, mainly institutional investors such as pension funds and insurance companies. Where do venture capital firms obtain their money?

11. The investment process starts from reviewing the business plan to actually Investing in a proposition, can take a venture capitalist from one to six months. There are always exceptions to the rule and deals can be done in extremely short time. The key stage of investment process is the initial evaluation of the business plan. Most approaches to venture capitalists are usually rejected at this stage. In considering the business plan, the venture capitalist will consider several principal aspects. The process can be illustrated by a figure as follows: What is involved in the investment process.

12. What is involved in the investment process. Is the product or service commercially viable? Does the company have potential for sustained growth? Does Management have the ability to exploit this potential and control the company through the growth phases? Does the possible reward justify the risk? Figure 5.1 Venture Capital Investment Process Does the potential financial return on the investment meet their investment criteria?

13. The rationale for venture capital is that the investor will expect a return on his money either by the sale of the company or by offering to sell the shares in the company to the public. Rationale for Venture Capital

14. There are three main types of venture capital that can be used in financing capital projects. These includes: early stage financing, expansion financing, and acquisition financing. These can further be explained in detail as follows: Types of Venture Capital

15. This type of financing consists of: seed financing, start-up financing and first stage financing. These can be further explained as follows: Seed financing- refers to small amount of venture capital given to an entrepreneur or investor who wishes to start up a business. It may be used to build a management, market research or developing a business plan. Start-up financing- refers to venture capital that is given when a business has been in existence for Early stage financing

16. less than a year. In this situation the product of the company may not have been sold commercially and yet they will just be ready to start doing so. First stage financing- is used when companies wish to expand their capital and to proceed full scale and enter the public business arena. Early stage financing cont….

17. This type of financing Consist of second stage financing, third stage financing and bridge financing respectively. These can be explained as follows: Second stage financing- refers to an investment used to expand a company that is already on its feet. That company in this case is trading and has growing accounts and inventories, although it may not be showing a profit. Early stage financing cont….

18. Third stage financing- refers to an investment to companies that are break even or becoming profitable. The venture capital is used to expand the business. It may be used in the acquisition of real estate or for further in –depth product development. Bridge financing- covers a variety of different meanings. It is a short term, interest only investment. It is used when company restructuring is taking place. The money can also be used if an initial investor wants to liquidate his position and sell his stock Early stage financing cont….

19. This type of venture capital refers to the used to acquire a percentage or the whole of another company. This type of finance can also be used by a management group to buy out another line of product or business regardless of their stage of development. The company they buy out can either be a private or a public company. Acquisition Financing

20. In structuring its investment, the venture capitalist may use one or more of the following types of share capital: Ordinary shares- These are equity shares that are entitled to all income and capital after the rights of all other classes of capital and creditors have been satisfied. Ordinary shares have votes. In venture capital deal these are share capital typically held by the management and family shareholders rather than the venture capital firm. Preferred Ordinary Shares- These are equity shares with special rights. For example, they may be entitled to a fixed dividends or share of the profits. Preferred ordinary shares have votes. Instruments for Venture Capital

21. Preference Shares- These are non- equity shares. They rank ahead of all classes of ordinary shares for both income and capital. Their income rights are defined and they are usually entitled to a fixed dividend (e.g.10 percent fixed). The shares may be redeemed on fixed dates or they may be irredeemable. Sometimes they may be redeemable at a premium (120 percent of cost). They may be convertible into a class of ordinary shares. Instruments for Venture Capital cont…

22. Loan Capital- Venture capital loans typically are entitled to interest and are usually though not necessarily repayable. Loans may be secured on the company’s assets or may be unsecured. A secured loan will rank a head of unsecured loans and certain other creditors of the company. A loan may be convertible into equity shares. Alternatively, it may have a warrant attached which gives the loan holder the option to subscribe for new equity shares on terms fixed in the warrant. Typically, they carry a higher rate of interest than bank term loans and rank behind the banks for payment of interest and repayment of capital. Instruments for Venture Capital cont…

23. Venture capital investments are often accompanied by additional financing at the point of investment. This is nearly always the case where business in which the investment is being made relatively mature or well established Instruments for Venture Capital cont…

24. Venture capital has the following characteristics: The investment in venture capital is usually for a period of five to seven years. The investor expects to hold a position in the Board of Directors The investor can demand repayments through the sale of the company. The investor may want to receive a percentage in the company’s equity. Features of Venture Capital.

25. In this section we explain what is meant by micro-financing is. In this part of the world micro financing play a significant role in mobilizing funds from and for low income groups who would have otherwise been left out of the traditional capital markets. So, what is micro financing ? Micro finance can be defined as the supply of loans, savings, and other basic financial services to the low income groups. In practice, the term is often used to refer to loans and other services from providers that identify themselves as “microfinance institutions” (MFIs). Micro Financing

26. Low income earners, like everyone else, need a diverse range of financial instruments to run their businesses, build assets, stabilize consumption, and shield themselves against risks. Financial services needed by the poor include working capital loans, consumer credit, and savings, pensions, insurance, and money transfer services. The MFIs commonly tend to use new methods developed over the last 30 years to deliver very small loans to unsalaried borrowers, taking little or no collateral. Micro Financing cont…

27. These methods include group lending and liability, pre-loan savings requirements, gradually increasing loan sizes, and an implicit guarantee of ready access to future loans if present loans are repaid fully and promptly. Together with providing financial services, many microfinance institutions work for social development in the areas in which they operate. Microfinance institutions generally have the following characteristics: Micro Financing cont…

28. Providing small loans for the working capital requirements of the low income groups. Minimal appraisal of borrowers and investments as compared to commercial banks. No collateral demanded; however, these institutions impose compulsory savings and group guarantees. Based on the loan repayment history of the members, microfinance institutions extend larger loans to the members repeatedly. Micro Financing cont…

29. Through microfinance institutions provide the necessary monetary support and try to increase social development. Microfinance is a poverty instrument against poverty. It is meant to facilitate access to sustainable financial services, increase income, build assets, reduce vulnerability, better nutrition, health, education etc. Micro Financing cont…

30. Typical microfinance clients are low-income people that do not have access to other formal financial institutions. Microfinance clients are usually self-employed, household-based entrepreneurs. Their diverse “microenterprises” include small retail shops, street vending, artisanal manufacture, and service provision. In rural areas, micro entrepreneurs often have small income-generating activities such as food processing and trade; some but far from all are farmers. Micro Financing cont…

31. The most common form of microfinance is microcredit, the extension of small loans to entrepreneurs who cannot qualify for conventional bank loans.  Therefore microcredit refers to very small loans for unsalaried borrowers with little or no collateral, provided by legally registered institutions. It is characterized by: Small size loans; Shorter repayment periods; Microcredit

32. Flexible and easy to understand regulations and needs; Small scale activities based on local conditions and needs; Clients are small entrepreneurs and low-income households; Loans used to generate income, develop enterprises and used by the community for social services such as health and education.   Microcredit cont…

33. This is where the Microloan foundation comes in. Microfinance and microcredit have two distinct advantages over charitable giving.  Firstly, it is sustainable and creates independence from aid, not dependence on it.  By giving a small loan to an individual, we hope to give them the ability to work their own way out of poverty.  Microloan lends to groups of about 10 to 15 people, allowing individuals to support, encourage, and provide assistance to each other if things go wrong. Microcredit cont…

34. Secondly, it means that the money goes directly to the people who need it - bypassing the bureaucracy and corruption that can compromise traditional methods of charitable giving. Moreover, Microloan never lends to individuals without first providing them with the expertise and training to build a business plan that is likely to succeed.   Microcredit cont…

35. THE END THANK YOU