A recent study by Clemens Löffler, Thomas Kaufmann-Lerchl, and Christopher Liska from the Competence Center for Business Controlling & Accounting at FHWien der WKW shows that it is important for companies not only to implement the right projects but also to consider the appropriate form of credit financing. These factors can determine how favorably capital can be raised.
Companies often face the challenge of financing multiple projects simultaneously. The obvious approach would be to simply select the best projects and finance each one individually through loans. However, the study shows that this solution is not always the most advantageous.
Financial flexibility through bundling stronger and weaker projects
The central question is whether projects should be financed individually through loans or whether it makes more sense to bundle multiple projects for borrowing. The result: When competition on the lender market is rather limited, joint financing of multiple projects can be beneficial. This is because, under certain conditions, more favorable credit terms can be achieved. A particularly interesting finding that may seem surprising at first glance: it can make sense to finance a very strong project together with a weaker one through a joint loan. This may sound contradictory at first. However, the study shows that this very bundling can improve the terms of financing. This gives the company additional leeway to move forward with its particularly promising projects.
Surprising study results using the example of a fictional bakery chain
A bakery chain wants to grow and is planning two loan-financed investments. The company has three possible projects for this:
- Project A: a new branch in a prime location
- Project B: the modernization of an existing branch
- Project C: a small pickup location in a suburban area
Intuitively, one would say: The company should, of course, finance Projects A and B — that is, the two strongest initiatives. However, the study’s findings show that this is not always the best solution. If banks do not compete strongly enough with one another when granting loans, it may make sense for the company to bundle A and C together in a single loan package rather than financing A and B.
The reason is that, in the case of bundled financing, the terms apply to the entire package. As a result, the strong Project A can benefit from more favorable loan terms. This is precisely the counterintuitive core of the published article: a weaker project can help make financing more attractive for the strong project.
Bank competition and equity influence bundling strategy
The study makes clear that companies should not view investment decisions and debt financing as separate issues. It is therefore not just a matter of selecting the most promising projects, but also of choosing the appropriate form of debt financing.
Two factors are particularly important here: the company’s available equity and the intensity of competition among banks. In the face of intense competition, bundling strategies lose their significance. If, on the other hand, the banking market is less competitive, bundling of projects can be a sensible way to make taking out loans more attractive for companies.
The study thus offers a new perspective on corporate financing: Sometimes the best solution is not the most obvious one, but rather the one in which project selection and lending strategy are considered together.