Financing v Funding: There is a difference
Financing and Funding
These sound like the same thing, right? But are they? When it comes to infrastructure investment, these are two separate concepts. Financing is defined as the act of obtaining or furnishing money or capital for a purchase or enterprise. Funding is defined as money provided, especially by an organization or government, for a particular purpose. For infrastructure investment, however, communities almost always look to external sources for money to complete projects. This money can be in the form of loan (financing), or grant (funding), or donations (funding), or investments from partner agencies (VTrans, for example; funding), or programmatic below market loans (State Revolving Funds or USDA-RD, for example; a mix of financing and funding). Financing sources need to be paid back but funding is often not if the work is performed in accordance with the funding agreement. Further, these two concepts are interrelated in that funding must be present to serve as a source of repayment for financing. Why the distinction? It is important to understand how different sources of capital can and should be used by a community. Questions a community should be asking itself to evaluate a project’s funding package or even a community’s overall capital investment strategy include:
- What can my community afford?
- What is the cost to finance?
- How does funding make up the difference?
- What are the funding options to make up the difference? And how easy are they to access?
Financing is relatively plentiful and easy to access. That, however, does not mean it is a panacea and ultimately, it is funding that provides the source of repayment after securing financing. Financing, in theory, is unlimited. Well, technically, according to Vermont State Statutes, a community’s debt capacity is limited to ten times the grand list value—an amount well above current debt amounts in any community. The real limitations to financing are a community’s willingness to undertake a project, pass a bond and take on debt. Even after a positive bond vote, a community must choose to apply to financial institutions for financing, including local banks and Bond Bank. Bond Bank provides low cost access to financing that would be out of reach for most Vermont communities on their own. However, just because there is easy access to financing does not mean that projects are affordable given the level of deducted annual funding needed to repay the debt. Fortunately, there are other sources of funding that do not need to be repaid and can bridge the affordability gap. Some things to consider about external funding sources are that those sources may be unreliable. Grant sources are time consuming to access and highly competitive and can obscure the true cost of infrastructure investment. Similarly, with investments from partner agencies, there is only so much funding to go around. Even access to programmatic below market loans, like the Clean and Drinking Water State Revolving Loans, are restricted in both the amount of money available and in the projects that are eligible. Plus, there are project development, bidding, and procuring requirements that may make those programs undesirable. Alas, there is no such thing as free money. How can funding sources be enhanced? Communities may choose to use reserves to support projects. These sources are accumulated slowly and over long periods of time, often the result of unanticipated revenue bumps in conjunction with decreased expenses. However, because they may not be significant source of money relative to the cost of capital projects, these sources may be better served as buffers in the case of emergencies, or to make up shortfalls when revenue unexpectedly dips (like in an economic downturn), or when expenses increase. Additionally, with relatively cheap capital accessible, the question of how much to set aside in reserves becomes more complicated. For more discussion of reserves, see Bond Bank’s Paying for Infrastructure publication. Lastly, using cash or reserves to fund projects instead of spreading the cost of the project over the expected useful life of the asset, ensuring those who are benefiting from the project are the ones who are paying much or all of it, is placing a higher burden on current tax payers/users. This is called intergenerational equity or fairness. What about pay-as-you-go funding? The concept of pay-as-you-go (PAYGO) funding is essentially budgeting annually for significant infrastructure investment. This would mean a community does not take on debt or takes on less debt to complete projects. So instead of budgeting for debt payments, the community would calculate how much it can spend in any given construction season and create a budget around that goal. An example of how this might fit into a budget is if a community has a large debt payment maturing, instead of taking on new debt or reducing rates/taxes, that community replaces that debt payment with annual capital projects in an equal amount. This is advantageous because the community is not having to take on new debt but can ensure capital plans are maintained. What is the right mix? This is where comprehensive capital planning and evaluating debt capacity can help communities figure out the best long-term strategy to balance sources of capital for infrastructure spending. But keep in mind, there is no ‘right’ answer as it will differ in time and place but putting in the work to plan will ensure choices are made in a clear and transparent manner, making them easier to communicate to an anxious public.