Greenfield Financing

Although they can be inherently riskier initiatives due to currency fluctuations, liquidity problems, and internal economic infrastructure issues, emerging markets are increasingly popular destinations for investors from developed economies, especially during periods of credit turmoil. According to the MSCI Emerging Markets Index, investors in the least risky of emerging markets achieved a record 73% return in 2009, (Platt, 2010). Companies seeking to secure external financing rather than utilize internally generated funds for Greenfield initiatives in emerging economies are faced with a choice between debt financing, equity financing, or some combination of debt and equity financing.

Many countries in Eastern Europe are still experiencing rapid growth as a result of the current global economic crisis; however countries whose currencies are pegged to the currencies of developed economies are experiencing a slowing down of investment. Currencies pegged to the euro, for example, are unable to take advantage of the speedier economic recoveries that are being witnessed in neighboring countries. The fixed exchange rate of the currency prohibits it from devaluing accordingly, thus these countries are currently experiencing protracted periods of output contraction, (CEE, 2009). Although FDI was down in Eastern Europe for 2009, in part due to a slowing of M&A investment activities, record high of inward FDI stock flows in 2009 that indicate there is still a feasible investment environment for foreign investment. While its appeal for M&A initiatives may be limited due to pegged currency issues, Eastern Europe is still a suitable location Greenfield initiative for a company wishing to maximize value for its shareholders.

Debt Financing Alternatives

Raising capital by borrowing it from creditors, either individuals or institutions, by selling bonds or other financial instruments, in exchange for interest payments or transaction costs on the amount borrowed can be advantageous in this economic environment due to lower interest rates. Although assuming additional debt may be still less preferable to internal financing, it is a less expensive method than utilizing equity financing to raise working capital and debt financing has the added incentive that a firm gains a corporate tax deduction. An additional feature is that when a company assumes new debt it is generally perceived as a positive sign by the markets and its shareholders are rewarded. Additionally, in the event that a company does not want to leverage itself more than necessary, debt financing can be supplemented by capital that a firm has readily available internally through withholding profits. In some situations the lenders may require that a firm utilize equity financing for a portion of the project before they are willing to issue debt, (Lupoff, 2009). Notably, taking on additional debt by an overvalued or over-leveraged corporation can sometimes result in a firm’s inability in making timely payments on the debt; a specific disadvantage to debt financing is that an overvalued firm, not wishing to appear as such, may seek additional debt in an attempt to disguise the fact that they are overvalued, (Eiteman, Stonehill, & Moffett, 2007).

Equity Financing Alternatives
Equity financing, or financing through securitization, involves a firm selling additional common stock; it is rarer and a more expensive alternative to debt financing due to the fact that shareholders must be compensated for the additional risk. Shareholders are compensated for equity financing by being awarded dividends or capital gains, however in the event it either cannot afford to or it wishes to retain the capital a firm does not necessarily have to pay these awards. Additionally, equity financing generally lacks the tax advantages a firm receives when it utilizes debt financing. Financing through securitization can be less risky than financing through debt if it is done through the use of an underwriter who is willing to certify the value of the firm’s new initiative by offering to assume any newly issued shares, (Eiteman, Stonehill, & Moffett, 2007).

Hybrid financing alternatives
Often firms utilize a hybrid method of equity and debt financing, often through the issuance of preferred shares, to obtain working capital for a project. Hybrid financing can be the best of both worlds as it can gain the tax advantages of debt financing and the payment advantages of equity financing; however, firms should proceed with caution as use of hybrid structures can be subject to limitations by the U.S. Treasury Department regulations. The Treasury Department utilizes five factors in determining debt to equity determinants of hybrid financing: 1. financing more closely resembles debt when there is a promise to pay on demand or on a specific date, 2. financing more closely resembles equity if it is subordinate to other debt, 3. financing more resembles equity if there is a high debt to equity ratio as most lender would not lend capital in this situation, 4. financing more closely resembles equity if it can be converted to common stock, and 5. financing more closely resembles equity when it is in proportional to the equity holdings of shareholders, (Chiang, Di, & Hanke, 2010). The Internal Revenue Service enforces these regulations through federal court actions, and additionally hybrid financing is also subject to the scrutiny of individual state courts. Recently there has been an extensive amount of litigation regarding hybrid financing by both federal and state courts, in either venue hybrid financing can be subjected to significant tax penalties. There are currently no specific quantifiable methods of determining the accuracy of utilizing this hybrid financing methods and state and federal courts often interpret and rule on hybrid financing strategies differently, as such, this method should probably be avoided when financing a initiative in an emerging market.

Conclusion
Often funding for Greenfield projects is nonrecourse or limited resource capital, meaning the cash flows from a Greenfield project are used to pay back the debt or equity that finances the project, with the initiatives assets used as collateral on the debt, (Lupoff, 2009). The single best alternative would be for a company to seek debt financing from a lender utilizing a nonrecourse or limited recourse capital structure for the Greenfield initiative as it is a less expensive form of financing and would impose substantially less risks upon the shareholders.







References:
CEE: Q3 growth – H1 trough plays out…mostly. (2009, November 23). Emerging Markets Monitor, 15(32), 14. Retrieved from EBSCOhost Business Source Premier.

Chiang, W., Di, H., Hanke, S. (2010, June). Debt or equity financing? Analyzing relevant factors. The Tax Adviser, 41(6), 412-418. Retrieved from ProQuest Accounting and Tax Periodicals database.

Eiteman, D., Stonehill, A., & Moffett, M., (2007). Business Finance for the Multinational Corporation. Upper Saddle River, NJ: Pearson/ Prentice Hall.

Lupoff, J. (2009, September). Top 10 things lenders look for when considering Greenfield industrial project finance. The Secured Lender, 65(6), 38-40. Retrieved from ProQuest Accounting and Tax Periodicals database.

Platt, G. (2010, February). Risk gets rewarded, but not too much risk. Global Finance, 24(2), 16. Retrieved from EBSCOhost Business Source Complete