Deciding if Financial Guarantees offer advantageous funding, and which one to use
For some developers, the challenge with our 4th cornerstone, Surety, is obtaining the optimal guarantee instrument that we require for funding. This article will help you sort out if it will be worth it, and which instrument best suits your situation.
Without a capital/financial guarantee, either issued by a Company, Bank or Sovereign Government (see below), mid-market project finance can be relatively slow-going, and fraught with pitfalls, depending on the project sector, location, portion of the total budget that requires funding, and state of construction-readiness.
Jump to our streamlined, more interactive (questionnaire-style) of this topic to help you decide whether to use a Bank’s Guarantee/Standby Letter of Credit (what’s the difference?), Company Guarantee (as a 1-page Commercial Promissory Note) or Sovereign Guarantee.
Further step-by-step decision support comparing these three Financial Guarantee Options.
What follows encapsulates the main reasons this Completion Assurance Program (CAP) funding deserves fair consideration
1. When securing funds is time sensitive
Time is usually of the essence when seeking project capital, in part because it is a long road just to develop projects to a state of readiness for funding. But if the developer conveys a sense of urgency, that alone can scuttle the entire transaction with traditional project financiers. Those with substantive capital resources at their disposal do not like to feel rushed, and will tend to slow things down deliberately just when the developer sees the need to move more quickly toward a commitment.
We designed our funding program with this in mind — stepping out of the “push/pull” conundrum with traditional funders to ensure that qualified projects can access attractive capital terms as rapidly as possible. Instead of “pushing” to go faster, we structurally arrange for more rapid due diligence, streamlined and largely pre-determined via a pre-qualification step. This need for speed is one of the problems we solve, described in full here, problem #3 of 4.
NOTE: Developers sometimes must gain the support of a sponsor or backer to access In3’s advantageous funding. We will be increasingly prepared to assist developers with securing such backing by early 2022, but for now, our role is primarily to assist with advising developers on the success strategies they can use to attract a stakeholder that will deliver the guarantee on behalf of their project.
Without such a guarantee, we would need to involve more expensive funding via partners of ours (indicative terms), or approach other investors in our network, which due to their diversity, can slow down the process and cause uncertainty that we happily bypass through our “next gen” Completion Assurance Program™ (In3 CAP funding).
2. Is the project actually completely ready to turn dirt?
If the developers are nearly out of money, but not yet fully shovel ready, how does CAP funding help? How is this capital different?
For some projects, “construction readiness” is equivalent to financial readiness, and thus fundamental to funding feasibility. Projects that have additional, pre-construction expenses seems like risks to funders. Anything left to chance could “unwind” the project’s viability and gaps between current state and the ideal, with a project that is fully developed and ready, can result in significant delays with securing funding. Or worse, funders will put terms and conditions (such as Condition Precedents) that give them undue rights “in case” things do not proceed as planned.
Even with projects that can begin construction right away, but still have technology or other risk factors, effectively “unsolved variables” (risks that can only be mitigated by doing the necessary work) could easily scuttle traditional investor due diligence. Some projects simply never get built due to this need for “bridge” funding. This requires careful, patient risk analysis on behalf of such bridge capital providers. More sophisticated investors will drag their feet or flat-out refuse to provide the necessary funding because they would be vulnerable — either a bridge lender would have no reasonable takeout option (if the project’s subsequent funding never arrives), or a longer-term capital provider would have little or no security, recourse, or certainty of completion. The risks outweigh the potential upside as worst-case scenario becomes a real stumbling block, with an uncertain path to beginning commercial operation and the start of cashflows. The greatest risk to developers, meanwhile, is not getting funding lined up at all. We solve that, most of the time.
Investor perception of risk becomes a fact; fear of loss can become overpowering no matter what the potential upside.
This predicament — developers often run short of cash to secure construction money — also points to why, in the current marketplace, In3 CAP uniquely fills an important gap, so when developers bring a completion assurance guarantee (either on their own or via a sponsor), it serves as credit enhancement during the pre-construction and construction phases and thus enables attractive terms for up to 100% financing to qualified projects, almost anywhere in the world (only a few countries are excluded at this time due to sanctions — more at qualified countries). More on this topic via our CAP FAQ.
Infographic that encapsulates these points:
3. How can you better align incentives with your EPC or construction firm?
A financial “completion assurance” guarantee is used only as security until completion and commissioning of the project assets (until Commercial Operation Date or COD). This is also different in kind from completion/performance/payment bonding (insurance) in that this private, alternative capital takes advantage of well-proven international rules and is not an insurance product at all.
The purpose is reaching completion of the asset, which means the parties must cooperate and work through any issues that may arise. Nobody gets to breach their contracts or refuse to talk about challenges — for the sake of the value delivered, the contractors and the developer plus any counterparties are held responsible for using the funding per the terms of the project’s Loan Agreement. Then, once operational, cashflows enable debt service, which would continue without a repayment guarantee — the developer and the funders become equity/JV partners. Sometimes the insurance gives the developer confidence in the EPC or construction firm’s ability to complete the project, but their sponsorship as a guarantor makes the entire process that much more secure. See this blog article for further details.
4. How can developers navigate this complexity?
With rare exception, there are few industry standards to ensure that projects reliably meet investor expectations for risk/reward, and even quite experienced developers can get frustrated by investors who negotiate using “wait and see” (indirect) or sometimes even hardball tactics. It can be stressful. Negotiating for the best terms with investors that are in no hurry, that can “take their own sweet time,” … can be frustrating, as developers usually just need straight answers, such as “can you fund this or not?”, and want to get on with it without wasting time. To developers, time is money lost. And yet, investors that take on completion risk need to be extremely careful, slightly paranoid, and highly selective.
This inherent tension often leads to disagreements about terms & conditions (especially risk-adjusted valuation and ownership splits), with investor fears of unknown or unmitigated risk factors, and even sometimes disputes that crop up due to differences of opinion during run-of-the-mill (but detailed) due diligence.
We solve almost all of that. We are proud to demonstrate that we’re faster and better organized than most project financiers because we have eliminated much of the complexity, and offer precise and thus predictable qualification requirements, which is mostly centered on bringing a financial guarantee used during construction. With a guarantee to offset asset completion risk, and filter out fraud, we’re flexible in ways that other lenders/investors, private or institutional, cannot afford to be. Our innovation translates into your advantages for access to affordable and reliable capital.
We radically improve funding certainty
Result? Without a financial guarantee, 2-3 months to closing is best case scenario except when developers have packaged a truly shovel-ready project with repeat investors that agree to “cookie-cutter” terms. By contrast, we average 2-3 weeks from when a usable completion assurance guarantee is pre-approved (sent later via hardcopy as the last step to reach closing), with first draw of funds 30-45 days after closing, even when forming new equity partnerships, setting up new Special Purpose Vehicles, or with developers seeking to finance their first projects.
How to Obtain & Use a Financial, Completion Assurance Guarantee
First, consider what party or parties have an interest in the project such that they could be willing, if properly approached, to post a Standby Letter of Credit (SbLC) on behalf of the project using a Bank Guarantee via SWIFT message type 760 (MT-760), which can be sent directly from one bank to another via the customary Brussels SWIFT system*. Recommendation: Well-established EPC contractors, equipment suppliers, general contractors, or “at large” private investors (high net worth individuals or family offices), and in some cases government agencies (with public/private cooperation) can be potential sponsors for obtaining a BG/SBLC, Sovereign Guarantee, or a simplified, commercial Promissory Note with bank Aval (AvPN) if developers cannot cover the bank fees and/or don’t have collateral the bank would be willing to accept (if they require collateral — some don’t) to authorize the guarantee.
Such a guarantee would only be in required, renewed annually, until completion and commissioning of the project assets (known as COD — Commercial Operation Date). Then it is released and allowed to expire.
Second, select a rated bank, preferably one with a reasonably strong credit rating (we use Moody’s). For BGs outside the US and Canada, the central bank, national or larger international banks (with US or European affiliates) usually have the asset depth needed for issuing a guarantee on behalf of their customer seeking to build major infrastructure projects. The selected bank does not need to be local to the project.
A copy of the SbLC/BG or AvPN verbiage to be used can be sent to us for pre-approval. This is recommended because the wording does matter (all templates available in MS Word with sample verbiage), then the actual SbLC/BG will always be sent via SWIFT MT-760 (AvPNs via hardcopy only) to our underwriters to ensure they can accept it, with MT-799 used to advise of the impending transaction and confirm capacity to fund. See outline of steps below.
* SWIFT provides a secure network of ~10,000 financial institutions in ~212 different countries. These SWIFT-registered institutions reliably send and receive information about their financial transactions. More at swift.com
Bank Guarantee Delivery Steps to reach closing (condensed version)
In keeping with bank compliance stipulations, our partners use the following steps for delivery of the SbLC/BG (AvPN is similar, except there is no SWIFT since the bank is only providing an Aval, and is not the issuer):
a) Issuing Bank provides a draft of the verbiage that will be used (templates here, see Step 3).
b) Bank Guarantee/SbLC MT-760 SWIFT verbiage is agreed.
c) Bank issues RWA (ready, willing, and able) letter stating bank’s readiness to issue the instrument for the specified amount. (Template available here.)
d) Developer send In3 complete package and partners finish due diligence 2-3 weeks later, and make binding offer of Terms & Conditions for funding. If accepted, all contracts are entered and delivered. Courtesy copy of MT-799 “pre-advice” is first sent by email to In3, then issuer delivers MT-799 via SWIFT or bank-to-bank email to receiving (underwriter’s) bank, which replies that it is “RWA” (adequate capacity) to fund the project per the terms & conditions.
e) Issuer sends instrument via MT-760. Scanned courtesy copy is sent to In3.
f) Issuer sends hard copy to receiving bank via bonded courier. This constitutes financial closing.
Download formal protocol here.
Project funds (combination of mezzanine debt and equity) are transferred once the funding bank receives a Bank Guarantee / Standby Letter of Credit (or other instrument) per an established schedule to carry out any pre-construction development steps, then initiate construction and complete the assets. The BG/SbLC stays in place until the project is commissioned and operating, then is allowed to expire.
When might it be advantageous to leave the BG/SbLC or Avalized Promissory Note (AvPN) in place after reaching Commercial Operation Date (COD)? Only when using extreme leverage; full answer
See our investment terms & conditions for the quantitative aspects of an acceptable project or portfolio to be financed — minimums do apply. Additional briefing materials are available to qualified project developers and their authorized agents for review.
Visit In3 Capital Group’s new client Resource Center for the latest news. This includes the launch in June 2022 of a “Done For You” (DFY) premium service to put a qualifying Completion Assurance guarantee in place for project sectors we know. More
Developers and sponsors can find handy reference materials here. For the full set of resource materials, tools, and tips, visit our “library” at in3capital.net/resources.