Hi everyone, one of my followers, @chelsea88, asked a good question.

She asked about the graphic I shared yesterday when I introduced to you the KG model of financing a ship. Here is the graphic again:

Now as I said, @chelsea88 asked a really simple but important question.  Can I explain the graphic in layman's terms please! 

All this graphic is saying is that the shareholders (think you and me) are protected because we don't invest directly into the operating entity (the vessel itself). We invest in the GmbH (German acronym for Company with Limited Liability). So it is a, let's say, efficient and low risk way (for people or companies who own ships) of getting people to invest in their shipping project if they want to buy a ship and rent it out. 

There are two key benefits as far as I can tell:

1. Higher likelihood of getting the bank to lend you a large part of the money.

Let's say, 10% of the money to buy the ship (this is called "equity", think of a deposit on a home). You don't have to ask a bank to lend you the full other 90%. And they would not want to either probably... it would be quite risky for the bank because freight rates are notoriously volatile. Freight rates are the amounts in USD that you get per day for renting out your ship. 

But not only that. Let's say you do hedge out your freight rate risk with forward freight contracts. In other words you lock in your rate...like with a fixed interest rate on your home. You then still have the issue of insurance companies not being willing, or reluctant to say the least, to insure ships that are worth hundreds of millions of dollars. First they are usually not able to judge the risk very well. They are not specialized at all in shipping. Secondly, the amounts are just too high. One claim (think of a sinking ship) would wipe them out!

2. The shipowner is protected if things go south

Let's say something goes wrong that is less drastic. Freight rates fall so much that the shipowner breaches his loan covenant with the bank. Or ship management costs skyrocket. And there is a clause in the contract between the GmbH and the shareholders that they have to be paid out at least some minimum amount if things go south. In that case, the shipowner does not end up having to pay the bank back more than the ship is worth at that point.

Both of these key benefits are positive when it comes to the world economy. 

Also of course the shipping industry in particular. These benefits make it more likely for anyone to want to put up equity for a shipping project. Whether it be as an owner - also called general partner, or a shareholder -  also called limited partner.

Have a wonderful day, and please ask if you have any questions. I am not an expert, but it is a fascinating industry. O yeah, and here's a very cool pic that gives a nice overview of the KG model as a whole and the relevant stakeholders: