There are three
main types of financing for a project: debt, equity and grants. Debt must be
paid back, but it is often cheaper than raising capital due to tax considerations.
Equity does not need to be paid back, but it relinquishes ownership to the
shareholder. Both debt and equity have their advantages and disadvantages and most
projects use a combination of both to finance operations. Grants are provided
to make the project financially viable (when the above two financing are not
adequate) taking into considerations of the social/economic benefits generated
by the project.
Equity is another word for
ownership. For example, the owner of a grocery store chain needs to grow
operations. Instead of debt, the owner would like to sell a 10% stake in the
company for $100,000. Companies like equity because the investor bears all the
risk; if the business fails, the investor gets nothing. At the same time,
giving up equity is giving up control. Equity investors want to have a say in
how the company is operated, especially in difficult times. So, in exchange for
ownership, an investor gives his money to a company and receives some claim on
future earnings. Some investors are happy with growth in the form of share
price appreciation; they want the share price to go up. Other investors are
looking for principal protection and income in the form of regular dividends.
Most people are familiar with debt
as a form of financing because they have a car loan or a mortgage. Debt
financing must be repaid, and lenders want to be paid a rate of interest in
exchange for the use of their money. Some lenders require collateral. For
example, assume the owner of the grocery store also decides that she needs a
new truck and must take out a loan for $40,000. The truck can serve as
collateral against the loan, and the grocery store owner agrees to pay 8%
interest to the lender until the loan is paid off in five years. Debt is easier
to obtain for small amounts of cash needed for specific assets, especially if
the asset can be used as collateral. While debt must be paid back even in
difficult times, the company retains ownership and control over business operations.
Grants are non-repayable funds provided by a grant maker (often a
government department, corporation, foundation or trust) to a recipient. Grants are of
importance, particularly, when a project is financially unviable but has a
large social and/or economic impact. Most grants are made to fund a specific
project and require some level of compliance and reporting.