How and why does In3 CAP Funding use a “Completion Assurance” guarantee?
Financial Guarantees serve as an excellent mechanism to obtain advantageous terms and enable access to funding that might otherwise be out of reach to project developers. Traditional loan guarantees stay in place for the life of the loan, mitigating the risk of default on the loan. They are often used by institutional lenders because the structure of such loans (using a Special Purpose Vehicle or SPV) provide limited or no recourse for the lender in case things go wrong. Traditional lenders also often use a senior lien (pledge of collateral) against the project’s assets as “first” line protection, with loan guarantees a close second.
Instead, and by contrast, with In3’s program, a financial guarantee opens access to advantageous funding (usually better terms) and a more reliable process, resulting in certainty, less guesswork, and fewer wasted steps. The guarantee itself acts as a source of assurance, transactional security, or “surety” that the project will be successfully completed and commissioned to begin commercial operations. Once the project reaches this milestone (Commercial Operation Date, or COD) the guarantee instrument is allowed to expire and is released.
While traditional lenders structure loans to mitigate the possibility of default (non-recourse loans become somewhat fail-safe in case the borrower fails to service the debt, as there is collateral and a loan guarantee as credit enhancement), while our Family Office takes on different risks, including credit risk, technology risk, and performance/execution risk.
The client’s credit enhancement extends only until COD. Offering up to 100% of the project budget is something banks would never do. Banks seek a separate equity partner or cash from the developer’s side to reduce credit risk. Our unique structure funds projects through a US family office using a combination of debt and minority equity carried interest, which will be negotiated and committed once we complete our due diligence.
Further, we do not ask for loan collateral (a senior lien on the project’s assets); instead we offer mezzanine debt, requiring no pledge of collateral as security once the project begins operations. The developer and our investment partner co-own the SPV’s project assets, enabling project developers/owners to build out qualifying pipelines more rapidly with this “Completion Assurance” Program™ (CAP funding) approach, advantageous terms and expedited process.
Facilitating such a guarantee for a non-recourse loan can be relatively straight-forward or quite a challenge, depending on (a) whether or not your own company has assets (balance sheet depth), or a strong enough credit rating, to involve a rated commercial bank or credit union, or (b) how you go about inviting a sponsor with deeper pockets to bring forward a guarantee on your behalf. For more on the “art and science” of using financial guarantee to secure this advantageous project funding see Definition, Motivation and Decision-making support, or read “Obstacle or Creative Opening” (article).
Why does this matter?
We usually offer better terms, making up to 100% funding accessible, and we reach closings by far more quickly (we reach closings in less than 30 days, once pre-qualified) than the traditional route. Our funder also fills the gap between the guarantee face value and the total required capital, usually as an equity “kicker” (exact amount to be negotiated upon completion of our due diligence, for which we do not charge), but without expecting control.
Short version of why: to obtain the benefits and advantages of In3’s “next gen” capital, and to radically improve funding certainty. We say “faster, easier, better.” For exactly how we achieve that for your particular projects, read on.
Such guarantees streamline investor/lender due diligence, ensure continuity and certainty of reaching closing(s), thereby greatly expedite funding, deliver better and more generous terms. Further, we can accommodate projects that are not yet shovel-ready (we can cover the costs of remaining development steps as part of the loan/investment package), and simultaneously overlook various other risks or vulnerabilities that would likely delay or outright kill opportunities for otherwise securing a project’s funding.
Defining & understanding financial guarantees
Both types of financial guarantees — Financial “Completion Assurance” and traditional Loan Guarantees are legal instruments (an official letter) that assign some or all of the responsibility for an investment or a loan. But in our case with In3 CAP, the instrument is used to access advantageous funding until completion of project construction and commissioning (COD). It transfers some of the risk of non-completion to the guarantor as a way to align the parties on project completion. We use the market value proportion of the guarantee instrument to access established commercial lines of credit (our bank sees and approves the instrument for this purpose), along with our partner’s own holdings as an equity investment.
By contrast, a loan guarantee would consider non-payment of the loan itself a form of default, while a financial (completion) guarantee instead uses the borrower’s breach of contract (loan agreement), such as due to fraud, malfeasance or other failure to honor obligations prior to COD, following a cure period. Nobody wants to see the instrument get called. Such guarantees are a “last resort” promise or pledge — a type of credit enhancement (improvement of the borrower’s credit profile) — in the event of non-performance.
They also differ from Completion Bonds (insurance), although such insurance “Completion Guarantee” products are often used by developers or hired contractors in addition to our CAP financial instrument. The difference is subtle, but important: Completion Guarantees are issued and backed by insurance companies, while financial instruments used for project financing involve a bank so that closings and funding can move with greater security, loans can be at lower rates of interest, and equity partners can be gained that do not expect a controlling interest. Project funds move on an automated draw schedule with certain aspects similar to so-called “Smart Contracts”. These and other innovations offer great advantages to project developers and their hired vendors, sponsors, intermediaries and contractors.
In3 project finance uses primarily bank-related guarantees (traditional “standby” or “demand guarantee” as a Bank Guarantee / SbLC or non-traditional Avalized Promissory Note) until COD to ensure that the assets are completed and commissioned to begin commercial operation. We can also accept a Sovereign Guarantee (more) with public/private cooperation, once it is verified by a rated commercial bank.
Benefit: a financial (completion assurance) guarantee frees up the parties to do their respective jobs, with …
- Less risk aversion by In3 investors, more streamlined due diligence, greater flexibility in working with issues, including a willingness to pay for any remaining pre-construction steps
- Greater speed and certainty in reaching closing and first funding (once pre-qualified, mutually-acceptable terms will be available within 2-4 weeks), and then less scrutiny after reaching financial closing, during construction, along the way to Commercial Operation.
- Fewer constraints or restrictions placed on the operating company, such as longer loan tenors (allowing plenty of time to repay the loan, no penalty for early repayment), ability to invest in the local currency, and no lien against operating assets (see below).
Financial guarantees serve to both expedite and backstop the capital, providing mutual protection from bad behavior such as fraud, gross negligence, or other incurable breach of contract.
Originally, sovereign guarantees were instituted to make up for market failures*, but in modern times, capital guarantees are now used in the commercial (private) sector to streamline project financing by simply holding developers and their counterparts to their promise to honor the terms of the financing. With In3’s Completion Assurance [Guarantee] Program™ (CAP), the guarantee is offered as a form of surety/security that the project’s assets will be completed and commissioned to reach COD.
Even if you are already familiar with loan / financial guarantees, or similar techniques for credit enhancement, please read our materials carefully, as there are many sharp differences between the conventional uses of guarantee instruments (namely trade finance, and so-called “documentary” letters of credit — see below for further clarification) and how they are used for access to this advantageous, next-generation project funding.
Conventional loan guarantees are used by most institutional, non-bank lenders as an additional layer of security (as a form of “credit enhancement”) until the loan has been repaid in full — for the “life of the loan.” Such lenders also require a pledge of collateral to secure the Senior Debt via the project’s operating assets — equipment, buildings, etc. Here, with CAP we require NONE OF THAT. We can accept either a Bank Guarantee / Standby Letter of Credit (BG/SbLC) or Avalized Promissory Note (AvPN) that goes away upon COD, there is no Senior Debt required (our offered debt capital is closer to mezzanine) nor is there a pledge of collateral via the project’s operating assets.
Instead, the project company or a third party sponsor (definition of the various types of potential sponsors) most often works with a rated bank to transfer completion risk to that institution. Upon COD the guarantee is dropped.
To be clear, a similar type of financial guarantee (a type of Letter of Credit or LC) is widely used in trade finance, an irrevocable “documentary” LC, issued by a bank to a third-party beneficiary and promising to pay on behalf of the transaction originator a specific sum of money against delivery of documents satisfying the terms and conditions of the LC. That is also not at all what we are doing here.
With project finance, the original asset or collateral underlying a Standby LC/BG is “preserved” and must remain “blocked” (the banking terms that means “held for a particular purpose”, in this case, the lender/beneficiary) until successful completion of the project. Upon reaching COD this SbLC/BG is released — technically, it is allowed to expire and thus goes away, with the underlying collateral left untouched. Some purchased SbLC can be cashed or monetized upon expiration, but that’s not what most In3 CAP customers do.
The asset type that can be used is up to the issuing bank and the project owner/developer/sponsor/backer. See below.
Whether a Bank Guarantee/SbLC or Avalized Promissory Note, we use Uniform Rules for Demand Guarantee (URDG, ICC publication 758; see below), and BG/SbLC and confirmed Sovereign Guarantees use the customary SWIFT system for bank-to-bank communication, where SWIFT itself helps maintain the chain of legitimacy, as any bank instrument of sufficient size will tend to attract fraudulent activity. (Example of a common such scam the FBI is tracking.)
We also now accept a Promissory Note (simple template available) that would be Avalized (a stamp or seal) by a rated bank. An SG, BG/SbLC or Avalized Promissory Note (APN) is issued in favor of someone other than the owner of the underlying asset (called the “beneficiary”), collateralizing the asset while allowing for an investment/loan against it. APNs are a special case, as they’re not issued by the bank, and the “exposure” to the bank depends on the asking party’s creditworthiness. More on APN’s advantages here
We pay careful attention to fairness and mutuality in these dealings, and although widely practiced, it is easy to misunderstand and assume there is no protection for the issuer if they are going to issue a guarantee in favor of another party to make sure they do not default. That is simply not the case. The issuer is fully protected under the preferred rules. See Note #3, below.
Further notes on this:
- Ordinarily, MT760 is used to block or set aside cash-backed assets — which does not necessarily mean cash on deposit, by the way, a misnomer — in favor of someone other than their owner. When an MT760 SWIFT is issued, the issuing bank puts a hold on their client’s funds, blocking the client from using them for another purpose temporarily, while the instrument is operative (in force). This arrangement does not USE the funds that are blocked; it is well controlled, and designed to see through the project’s completion, then the underlying asset is released (technically, it is allowed to expire and fall away on the “maturity” date).
- Note that, once issued, if there are no loan funds transferred, then the BG/SbLC or APN has no effective value. In fact, it can be unwound or returned right away, not that anyone would actually do that, having come that far. Just clarifying for bankers that may confuse this SbLC or APN with trade-related transactions (Documentary LCs), where the guarantee serves to protect sellers (exporters) and buyers (importers), where the underlying capital assets are transferred (paid) to the seller upon satisfaction of the terms of the transaction. With a project finance-related guarantee, the instrument is released and returned to the guarantor upon project COD (completion of the project construction/commissioning) per the terms/conditions of the loan agreement.
- Under these banking rules (more here), the guarantee issuer (the project developer/owner/sponsor) is protected against the guarantee being arbitrarily called or used for any purpose other than intended — backstopping the project financing. Thanks to well-proven Uniform Rules for Demand Guarantees, ICC pub. 758 (URDG 758) it is quite safe because it is difficult to make a claim against or “call” (cash or draw on) the instrument and prevail in the courts.
If unfamiliar with how this works, see our Practitioner Series article for a deeper dive into the legal intricacies and independent legal review of this well-proven international venue.
In general, guarantors can be any of the following:
- An involved private party, such as a well-established engineering (EPC) firm or general contractor, technical services or diversified corporation, usually with a commercial interest in the project. Offering a modest equity carried interest helps align incentives, but some well-established EPC or general contractor firms do not wish to own an equity stake.
- At large “sponsors” or “backers” such as private family offices (single or multi), dedicated funds, or specialized impact investors of various types. Their guarantees usually involve offering a equity carried interest in the project.
- sovereign governments — typically the Minister of Finance can issue a Sovereign Guarantee (SG) on behalf of the nation’s treasury. Developed countries will not issue SGs (they don’t need to), nor will the poorest (IDA) countries, typically, except when the IMF does not object.
- development finance institutions like Export-Import (ExIm) Banks, regional development banks or multilaterials like U.S. International Development Finance Corporation (DFC, America’s development bank, formerly OPIC & USAID), though such institutional guarantees would be heavily discounted.
More possible sources of a project’s guarantor at our success tips FAQ on sponsors.
More about the underlying rules for such project finance transactions with Bank Guarantees / Standby Letters of Credit, called the Uniform Rules for Demand Guarantees (URDG 758), including legal analysis that compares who benefits and to what degree.
Will it be worth it? What are the tradeoffs?
In all cases with project finance, the guarantor assumes an obligation only if the borrower defaults (material breach of contract following a reasonable “cure” period). In that unlikely event, which really must not happen, some investors or lenders would not “call” (require repayment) of the loan, as the existence of the guarantee enables the parties to work through any issues and, if there is no way to finish the project, come to an equitable solution. In that sense, guarantees avoid or prevent criminal actors and their unethical practices of fraud, malfeasance, money laundering, etc.
Guarantees constitute leverage and can be used to greatly enhance the developer’s credit while qualifying for better investment/loan terms, faster closings, and greater freedoms than could otherwise be afforded without similar accountability / backstop / surety.
More at our Capital Guarantee Program FAQ on this topic of how developers can be assured that the guarantee will not be called: in3capital.net/frequently-asked-questions/#faq-6 and how the guarantee can be used in3capital.net/frequently-asked-questions/#faq-2
In conclusion, such BG/SbLCs, APNs or SGs they are not for everyone, and also not free to the project owner, with three exceptions: 1) Sovereign Guarantees (not available in all countries), or 2) When a sponsor, such as an EPC firm or general contractor, can be involved as the source of the qualifying guarantee, or 3) When a company issues an Avalized Promissory Note (APN), where the bank providing the Aval views the PN as coming from a creditworthy customer, in which case no collateral is required, and the bank typically does not charge the issuing company for the Aval — or at most, charges a nominal processing fee. But if not creditworthy, the bank will likely say the PN issuer will need collateral as their Aval makes them a likely target in the event of default.
Here is an implementation guide: Nine Steps to Project Fundraising Success using CAP.
How can In3 help a developer secure a guarantor for CAP funding?
We can help arrange guarantees for projects we finance under a Management Services Agreement, with a tightly defined scope-of-work and timetables for each milestone and deliverables. To avoid these service costs, if you are seeking project capital, better to bring forward your own guarantee as part of qualification for CGP funding.
There are no up-front fees whatsoever if developers bring forward the required capital guarantee without asking us obtain one on behalf of their project. Our preferred model is direct financing of qualified projects. Toward that result, we have developed extensive tools, templates and other resources available to help coach and guide developers to accomplish this. Start with this 2-page worksheet.
Our In3 Registered Affiliates may also be adept in building your project’s qualifying profile as they have received training via our MasterClass to serve your needs.
For example, we offer sample contractual language to assist you with proposing a Capital Guarantee (usually in the form of a Bank Guarantee or Standby Letter of Credit) to firms you are interviewing for handling key functions like project engineering or construction. More at CAP Proposal Builder
Is a capital guarantee right for you?
History shows that it has worked out well for many developers seeking faster, easier and better access to available capital for qualified projects of US$25 million or more.
All that said, we realize CAP is not for everyone. Some developers just do not have the patience or drive to explore possible sources of a qualifying completion assurance guarantee, which would be unfortunate (the advantages would far outweigh the costs or effort), but fine. The only time CAP does not work — which is the one time that qualification is just not within reach — is when the developer has no liquidity, inadequate credit, and also no possibility of gaining support from a backer/sponsor/senior lender (minimum 30% of the project’s total funding, perhaps delivered in 2 or more tranches or chunks) because there is no contractor or well-established vendor or anyone else that can be involved. The project is just not solid enough to involve others.
This unfortunate scenario assumes the project is also not part of a public-private cooperation with a national government agency involved that could “sponsor” that way, or some other, creative solution. Is that true for your situation? It is rare, but it happens.
More at options & resources for new In3 Clients
Contact us with questions or for further information on how to take advantage of In3’s Completion Assurance Program to accelerate project finance closings and obtain the best terms.
* “Market failures” in the sense that small borrowers, regardless of creditworthiness, sometime lack access to the credit resources available to large borrowers. (More at article or original paper at EconBiz.de archive.)
Difference between a Bank Guarantee and a Letter of Credit (LC or Standby LC / SbLC) on Quora, but in the US and most developed economies, a BG and SbLC are effectively the same thing. As stated above, UNLIKE trade finance, that uses these instruments to guarantee payment upon receipt of goods, In3’s CGP uses a BG/SbLC or APN to ensure completion of a project’s construction and commissioning to commence commercial operations. In other words, it is designed to prevent fraud.
