Types of Funding — Project Finance, Trade Finance, and Venture Finance
What are the uses for, and sources of, different types of financing?
What are the main distinctions between project finance, trade finance, corporate finance and venture capital? They all have much in common, especially at first glance. Most sources of capital specialize, so it is helpful to know what type of capital best fits your fundraising situation. This article compares their respective differences and similarities.
While project and venture capital are usually longer-term (3+ years), trade finance combines working capital lines of credit (where capital is typically paid back within 6 months). Both project and trade finance usually require insurance or other guarantees, of different types, with trade often handled through an export credit agency.
The most common form of venture capital is early-stage, sometimes “seed stage” or “startup” funding. Corporate finance describes funding for an established company seeking to grow or expand its own operations, or to acquire, merge, do a roll-up (Mergers & Acquisitions or M&A) or more “organic” growth strategies. Some project financiers also do M&A but the mainstay for project finance is “greenfield” (new construction), retrofits and renovations.
To gain most investor/lender-favored attention requires documentation of the history (if any), financial status, and planned uses for proceeds, and each involves various strategies for reducing or eliminating risks. Your team’s track-record and experience are important, but even startups, “greenfield” projects, and initial trade transactions can gain support with the right planning and preparation.
Project finance is In3’s primary specialization since 2004, and is typically used to build something tangible, as opposed to activities like setting up an overseas sales office, or to hire a team that would introduce a new product, and thus projects involve mostly tangible assets where predictable future cash flows can be used to advantageously leverage limited or non-recourse term loans (lasting 3 or more years).
The legal entity used to finance projects is known as a Special Purpose Vehicle (SPV) and is the extent of legal recourse in the event of a loss (if the project fails, or defaults). The borrower cannot ask the owners to repay the loan (they won’t lose their personal residences, for example) if their project fails. The “non-recourse” nature of project finance — more at glossary — means the entity that owns the project’s assets is the limit of the borrower’s liability in the event of default.
This is why lenders often ask for a senior lien against the project’s assets as collateral — so in the event of borrower default, the lender is not likely to experience a total loss. Institutional lenders also often ask for a loan guarantee to enhance the borrower’s credit. Such guarantees, to be meaningful, are backed by assets or the strength of a balance sheet with many years operating history. More on these project-related themes:
(a) Advantages of project finance
(b) What are the main technical differences between project and venture finance?
Trade finance, by contrast, is the capital needed to buy or sell, import or export, products or other tangible goods, and often requires or benefits from short-term working capital (export/import finance, guaranties or insurance to enable transactions), but rarely involves protracted loan repayments. Typical trade transactions are less than 3-6 months. Working capital lines of credit are available from commercial banks, Import-Export Banks, and others.
Venture finance, including venture capital, is raised by companies doing fundamental innovation, or expanding and seeking to build enterprise value for shareholders. Companies sell an equity interest or borrow to raise money, or both (hybrids include structures such as convertible debt or revenue contracts).
Traditional sources of early stage venture funding are the company’s founders, management’s friends and family, angel investors or angel groups, then later (except for those that are seed-stage-focused) venture capital funds, boutique VC/PE firms, and other institutional investors like certain impact investment funds, high-growth pension funds (rare), corporate or multilateral investment funds.
Corporate finance, including corporate fundraising, is an entirely separate, well-established field that can often involve private equities, private or public debt capital (such as bonds), public equities (such as from “going public” and offering an IPO or being acquired by a publicly-traded entity) with multiple types of shares, including preference shares, and so on, used for growth, M&A, buyout/rollup/consolidation, share buyback, restructuring, and so on. More on this here.
Why we focus on Project Finance and early-stage Venture Capital
Projects offer the most scalable, capital-efficient and replicable opportunities to have a positive impact on global markets. They use cash flows to repay debt, and are secured by tangible, physical assets (existing ones, or those to be procured as a result of financing, also called ABL or asset-based lending), sometimes used as a pledge of collateral, and/or sponsors that can guarantee completion of the project, or with more traditional capital providers, a loan guarantee for the repayment of a loan, minimizing risk to the lender(s). Lower risk profiles and long-term debt translates into lower interest rates and greater leverage.
What’s in it for such an investor? Remember that debt finance is quite inexpensive these days — so the lender stands to gain only repayment of the loan plus modest interest, at best. Impact capital seeks to make a real difference, delivering developmental benefits through worthwhile projects. Although this is often the true mission of such lenders, loan repayment is fundamental — investors are not going to lose money if they can possibly help it.
By contrast, venture finance uses the balance sheet of the company, with debt sometimes secured against tangible assets. There are very few guarantees in venture capital, and venture capitalists usually look for fundamental innovation (such as developing a new, breakthrough product, service or technology) with the potential for three-fold or greater returns during the life of the business plan.
Venture money is often called “risk capital” or even “adventure capital.” Only a few companies are fortunate enough to provide substantial returns; the rest either fail or barely succeed.
For most young companies, the challenges with venture financing (vs. project financing) will occur either with meeting the right investors, to ensure alignment where it counts, or when coming to terms with those investors (called “gaining traction”). This is, in part, because it is difficult for angels and VCs to accurately assess let alone mitigate the risks with early stage, innovative, sustainability-oriented companies. The future can be very hard to predict, even for the best venture capital firms.
VCs get a bad reputation when they seek 7-10x returns, or wish to control a majority interest in their portfolio companies, because they see such aspirations as “risk adjusted” returns — meaning, they stand to lose all their investment, so when they succeed, it should pay for their other loses.
Instead, drive a harder bargain. Both startups and established companies that qualify for project finance can systematically eliminate the major risks (commercial, technology/performance, regulatory, political, etc.) and reliably gain access to attractive capital from $1 million to million or more.
Learn more about why project finance and how it works.
Take next steps to secure venture financing.
