In a previous post, I mused on the relationship (or, rather, lack thereof) between project management and innovation. Apparently, the person I was responding to has a blog chock-full of well-meaning, but often misguided, posts. Here’s the latest so far:
A great question that we can ask ourselves as project managers is, “Would we invest in our projects”?
What’s so great about this question? A lot of projects out there are not investable; they make no sense outside the organization implementing them and thus cannot be detached from it. Bankers know it and finance such projects based on assets and/or cash flows of the entire implementing company. In other words, bankers do not “invest in projects”; they lend against assets and cash flows of the entire company, however many projects it happens to have on hand at the moment.
Even if the project is detachable and thus investable, no two investors are alike; every investor has a specific combination of return requirements, risk tolerance, and constraints that define the investor’s choice of investment policy. In practice, very few of those detachable projects are suitable for an individual investor.
From an outside investor’s standpoint, investable projects generally fall into two categories:
- Private equity deals with situations when the “project” at hand is an entire company (or a division of a larger company well on its way to become an independent company). In a typical private equity transaction, outside investors seek majority ownership. Additionally, the transaction may involve a debt or preferred equity component.
- Project finance is similar to private equity in that the project is structured as a standalone company, but the terms of financing are very different. The project organizers (or, in project finance lingo, “sponsors”) own 100% of the project company’s equity, but equity accounts for a very small part of the required capital. The bulk of capital is contributed by outside investors (typically, a lending syndicate including several large banks) on terms resembling convertible debt with an extended grace period; if the project company fails to repay debt on schedule, creditors simply take it away from the sponsor(s) and assume ownership.
Low liquidity and long time horizons are typical for both categories. The level of (largely fixed) transaction costs is such that both arrangements are feasible only for relatively large projects. Put it all together, and what do you get? A pool of investment opportunities suitable only for institutions and accessible only through specialized intermediaries (private equity funds and project finance arrangers). Hardly an investment program an individual project manager can subscribe to…