"Money Matters: Demystifying Due Diligence and Other Funding Costs in Project Financing"
We have received many questions from prospective borrowers about Due Diligence Fees and Other Funding Costs in Project Financing. Most borrowers came with the idea that they do not need to pay any fees and expect lenders to cover all costs associated with the funding program and often asked lenders to deduct it from the loan at closing.
Thus, we hope that by sharing this high-level overview of "Money Matters: Demystifying Due Diligence and Other Funding Costs"
would offer valuable insights to project owners and developers embarking on large-scale projects, ensuring they're equipped with the knowledge to navigate the complex landscape of project financing.
We'd delve into the concept of "skin in the game," explaining why it's crucial for borrowers to invest their own capital into the project. Key reasons would include risk sharing, credibility, alignment of interests, project feasibility, equity, and regulatory compliance.
What is "skin in the game?"
It is a phrase used in finance to refer to a situation in which an individual or organization has a significant personal investment in a project or decision. This concept ensures that those who make decisions bear the risks of those decisions. It originates from the idea that you are more likely to be committed and responsible when you have something at stake or some "skin" in the game.In the context of project financing
- Personal Financial Stake: The concept of "skin in the game" refers to project owners, sponsors, builders, and developers investing their own money into a project. This capital contribution shows their personal commitment to the project. It reduces the risk for lenders, as those with "skin in the game" are more likely to ensure the project's success because they stand to lose personal funds if it fails.
- Risk Sharing: When project stakeholders invest their own capital, it shows that they're willing to share the risk with lenders and other investors. This often gives lenders more confidence in the project, as the stakeholders' personal risk can motivate careful project management and execution to protect their investment.
- Alignment of Interests: Having a personal financial stake aligns the interests of project owners, sponsors, builders, and developers with those of lenders. When project stakeholders stand to lose their own money, they are less likely to make decisions that could harm the project and more likely to work diligently toward its success.
- Credibility and Trust: When project stakeholders put their own capital at risk, it signals confidence in the project and its potential profitability. This can enhance the project's credibility and build trust with lenders and investors.
- Equity: Lenders generally prefer projects where the owners have a significant equity stake. This makes it less likely that the owners will abandon the project if it encounters difficulties.
- Feasibility: A personal investment can serve as proof of the project's feasibility. It shows that the project owners have done their due diligence and believe the project to be profitable.
- Compliance: Regulatory bodies often require project owners to invest a certain percentage of their own funds in a project.
In summary, "skin in the game" in project financing is about more than just having a financial stake. It's about demonstrating commitment, sharing risk, aligning interests, and building trust. It shows lenders that the project stakeholders are involved and committed to seeing the project succeed.Why Must Borrowers Be Prepared To Pay For Due Diligence and Other Funding Costs?
What Should Borrowers Do?
- Covering Expenses: Lenders incur significant costs when evaluating a loan application, including appraisal, legal review, and due diligence. The borrower pays these costs to cover the lender's expenses.
- Risk Assessment: Due diligence is a critical step in assessing the risk associated with a project. This research and analysis process enables lenders to determine a project's feasibility and potential profitability.
- Responsibility: As the individuals or entities who stand to benefit from the project, it is only fair that borrowers should bear some of the upfront costs. This also underscores their commitment to the project.
- Legal Requirements: Legal costs associated with loan agreements are often borne by the borrower. These may include drafting and reviewing contracts, registering collateral, or litigation if there's a default.
- Capital Planning: Borrowers should have a clear plan in place for how they will cover their share of the project costs, as well as any additional expenses such as due diligence fees, legal costs, and lender's fees.
- Building Reserves: Borrowers should aim to build up a reserve of funds to cover unexpected costs or setbacks. This will help to ensure the project's sustainability and enhance its credibility in the eyes of lenders.
- Understanding the Costs: Before seeking funding, borrowers should take the time to understand all of the costs associated with a loan, not just the principal and interest. This includes costs such as lender's fees, due diligence fees, and legal costs.
- Negotiation: In some cases, borrowers may be able to negotiate some of these costs with their lenders. However, this is more likely if the borrower can demonstrate a strong financial position and a sound project plan.
- Seek Advice: Borrowers should seek advice from financial advisors or consultants to understand their financial obligations better and to ensure they are ready for the responsibility that comes with project funding.
Understanding the significance of having "skin in the game" and being prepared to shoulder due diligence and other funding costs is crucial for project owners, sponsors, builders, and developers when securing project financing. By investing their own capital, they demonstrate a commitment to the project, enhance their credibility, and share the inherent risk associated with the venture. This alignment of interests between borrowers and lenders often leads to better project outcomes and lower default rates.
Being prepared to cover costs such as due diligence, legal fees, and lenders' fees is not just a financial responsibility but also a reflection of the project's feasibility and the borrower's commitment. These expenses are necessary for risk assessment and legal compliance, allowing lenders to gauge the project's potential profitability and mitigate risks accurately.
Understanding these principles can lead prospective borrowers and developers to more successful interactions with lenders and greater chances of securing the necessary funding. In turn, this can enhance their projects' overall sustainability and success.
It's recommended that borrowers undertake thorough capital planning, build financial reserves, and fully comprehend all costs associated with securing a loan. This includes seeking advice from experienced financial advisors or project financing consultants and sometimes negotiating terms and conditions with lenders. With that said, please keep in mind that sometimes borrowers are not able to negotiate the terms and conditions because lenders have the right to manage and control it since they are the ones who will provide funding in millions of dollars to borrowers, especially in the 100% Financing Program such as in the Joint Venture Partnership when lenders not only provide the majority of the loan and also equity (e.g., 60% loan and 40% equity shareholding).
Ultimately, this understanding and proactive approach will ensure borrowers are well-prepared for the responsibility that comes with project funding. This maximizes the likelihood of project success and helps build long-term relationships with lenders, opening opportunities for future projects. In the complex landscape of project financing, having "skin in the game" and a clear understanding of all financial obligations is the key to sustainable success.
At Hakim Saya
, one of our specialties is project financing. We have partnered with a few direct private lenders and private investors specializing in project financing. They provide project financing worldwide, except in countries where the U.S., U.K., and Canada imposed international sanctions.
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can help you overcome financial challenges and unlock new opportunities for your project financing. Visit www.hakimsaya.com
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