Macro-economic factors (and finance leaders' feelings about their near-term future) strongly influence the funding prospects for projects. Two prominent factors are the availability of capital at a reasonable cost and and the expected organic growth of the firm (which tends to be influenced by expected growth of the economy at large).

The cost and availability of capital tends to move in a cyclical fashion. This is well documented by Howard Marks in his excellent book Mastering the Market Cycle. The cycle is influenced by the actions of central banks like the Federal Reserve. For the last couple of years, the Fed has been attempting to make credit more costly to reduce inflation. It looks like the Fed is about to ease up a little, but it may be a long time before we see easy money like we saw in response to the COVID pandemic.

Other factors come into play as large banks and investors become more or less willing to extend credit. The cost of equity funding is strongly influenced by the interest rate on risk free investments. Because of the risk of default, non-governmental debt must yield a higher rate to attract investors. Equity funding is not secured by anything, and is the last set of obligations to be paid in the event of a liquidation, it is the riskiest option for investors. As a result, they demand a premium over what they could earn in less risky investments. All things being equal, a demand for a high rate of return compresses the multiples (whether profits, sales, book value, etc.) that investors are willing to pay for shares of a firm.

What does that mean for project funding? When the risk free rate of return is low, firms can borrow at a low rate. Depending on where the pendulum of investor psychology and credit is along it's swing, firms may be able to issue new shares at a high valuation. During the meme stock craze, Gamestop was in the midst of a short squeeze that drove it to completely unrealistic valuations. Management smartly chose to issue new shares at the inflated price, which dramatically improved the cash position of the company and bought them time to return to profitability.

In difficult economic times, governments are prone to engaging in various forms of stimulus. Sometimes, the stimulus is broadly distributed (tax rebates and the like). In other cases, stimulus is targeted toward specific industries (for instance, grants and loans to the airline industry in response to the pandemic). Government stimulus ordinarily occurs at the same time as low interest rates and amplifies their impact. Near the end of the pandemic, we found ourselves in an unusual circumstance where central banks were attempting to slow economic growth, but governments were expanding budgets in ways that had more money flowing directly to some constituents.

What is the consequence of that for project funding? When capital is cheap and easy to obtain, the hurdle rate for projects decreases. Anecdotally, it seems like CEOs and finance leaders become less strict in their process for capital allocation. Budgetary discretion expands lower in the management chain and the number of approvals required decreases. This same process happens across entire industries. Even if capital discipline is a core value for a firm, it can be difficult to maintain in the face of competitors' willingness to make capital investments. In the case of government funded grants and loans, recipients may undertake projects that they otherwise would not consider. As a typical example that you have likely seen in your personal life, consider the friend we all have who put solar panels on their house in the last few years because tax credits made it a feasible investment.

At the other end of the cycle, lenders and investors are cautious. They are less willing to place money with firms that don't have a clean balance sheet, accounting profit, and healthy operating cash flow, and they demand a greater premium above the risk free rate for doing so. This has at least three impacts on project funding.

The required rate of return for projects (the "hurdle rate") increases. Capital projects that were reasonable, but not spectacular, uses of capital no longer make sense.

An emphasis on improving financials leads to greater scrutiny. Funding projects out of budgeted expenses becomes difficult as finance leadership puts fresh focus on driving unnecessary expense out of the organization.

For public companies, if investors' demand for higher yield leads to a major drop in share price, executive leadership will often myopically focus on what can be done immediately to drive an improvement in share price. Their bonuses and their continued employment may depend on it.

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