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Financial Package; Section of information memorandum dedicated to the financial structure of the project in question. The financial package specifies the mix of capital that is consistent with the project’s financial flows and the economic structure. (Project Finance in Theory and Practice – Gatti, Stefano, 2013)
Finance Documents; Documents defining the legal aspects of the deal. Finance documents are drawn up by the arranger’s lawyers and negotiated with the project company’s lawyers. (Project Finance in Theory and Practice – Gatti, Stefano, 2013)
Special Purpose Vehicle [SPV]; Ad hoc legal entity established to realize a give project. The primary roles of the SPV are borrower towards lenders, counterparty to contracts underpinning the initiative, and owner of the project cash flows. (Project Finance in Theory and Practice – Gatti, Stefano, 2013)
ADB: Asian Development Bank
ADC: African Development Corporation
AfDB: African Development Bank
ADF: African Development Fund
ABEDA: Arab Bank for Economic Development in Africa
CDC: CDC Group (Commonwealth Development Corporation) is the UK’s Development Finance Institution (DFI) wholly owned by the UK Government’s Department for International Development (DFID).
EADB: East African Development Bank
EBRD: European Bank for Reconstruction and Development
EIB: European Investment Bank
EDFI: European Development Finance Institutions
IADB: Inter-American Development Bank
IBRD: International Bank for Reconstruction and Development [member of the World Bank]
ICSID: International Centre for Settlement of Investment Disputes [member of the World Bank]
IDA: International Development Agency [member of the World Bank]
IFC: International Finance Corporation [member of the World Bank]
KfW: Kreditanstalt für Wiederaufbau [German Government-owned Development Bank]
MIGA: Multilateral Investment Guarantee Agency. [member of the World Bank group]
DBSA: Development Bank for Southern Africa
IMF: International Monetary Fund
OECD: Organisation for Economic Co-operation and Development
BRICS: Association of five major emerging national economies: Brazil, Russia, India,China,South Africa
BRICS Development Bank is a proposed development bank of the BRICS nations
ADSCR: Average Debt Service Cover Ratio
BOOT: Build, Own, Operate, & Transfer
BOT: Build, Operate, & Transfer
Capex: Capital Expenditure
DBFO: Design, Build, Finance, & Operate [i.e. PPP]
DBO: Design, Build, & Operate [i.e. PPP]
DSCR: Debt Service Cover Ratio
EPC: Engineering Procurement and Construction
ECA: Export Credit Agencies
FAC: Final Acceptance Certificate
IRR: Internal Rate of Return
LLCR: Loan Life Cover Ratio
MBL: Maximum Probable Lost
NPV: Net Present Value
PPA: Power Purchase Agreement
PFI: Private Finance Initiative
PAC: Provisional Acceptance Certificate
PPP: Private-Public Partnership
WACC: Weighted Average Cost of Capital
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Acquisition Loans
Acquisition loans are sought when a company wants to complete an acquisition for an asset but doesn’t have enough liquid capital to do so.
The company may be able to get more favourable terms on an acquisition loan because the assets being purchased have a tangible value, as opposed to capital being used to fund daily operations or release a new product line. If the business being sold is very profitable, the selling price will likely reflect a significant amount of goodwill which can be very difficult to finance. If the business being sold is not making money, lenders can be difficult to find even if the underlying assets being acquired are worth substantially more than the purchase price. An acquisition loans, or change of control financing situations, can be extremely varied from case to case.
Like most business funding types, qualifying for acquisition loans comes down to the value of the business being acquired, the borrower’s credit history, and the collateral the borrower has to help mitigate the risk for the bank. The better prepared you can be with information to substantiate all three of the items, the quicker you can be approved for an acquisition loan. Acquisition loans are typically only able to be used for a short window of time, and only for specific purposes.
There are several different choices for a company that is looking for acquisition financing. A line of credit or a secured loans are the most common choices. Favourable rates for acquisition financing can help smaller companies reach economies of scale and is generally viewed as an effective method for increasing the size of the company’s operations. Once repaid, acquisition loan funds cannot be re-borrowed like a line of credit.
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Bridge Loans
Bridge loans are short-term loans (up to one year) with relatively high interest rates and are backed by collateral.
A bridge loan is interim financing for an individual or business until permanent or the next stage of financing can be obtained. Money from the new financing is generally used to “take out” (i.e. to pay back) the bridge loan, as well as other capitalization needs. As the term implies, bridge loans bridge the gap between times when venture capital is needed. Bridge loans are used by corporations and individuals and can be customized for many different situations.
Bridge loans are used to secure working capital until the round of funding goes through. Bridge loans are common in the real estate market where there can often be a time lag between the sale of one property and the purchase of another, and a bridge loan allows a borrower more flexibility. A bridge loan is similar to and overlaps with hard money loans. Both are non-standard loans obtained due to short-term, or unusual, circumstances. The difference is that hard money refers to the lending source, usually an individual, or private company that is not a bank in the business of making high risk, high interest loans, whereas a bridge loan refers to the duration of the loan.
Bridge loans are typically more expensive than conventional financing to compensate for the additional risk of the loan. Bridge loans typically have a higher interest rate, points and other costs that are amortized over a shorter period, and various fees and other “sweeteners” (such as equity participation by the lender in some loans). The lender also may require cross-collateralization and a lower loan-to-value ratio. On the other hand they are typically arranged quickly with relatively little documentation. (see also secured loans)
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Construction Loans
Construction loans are value added loans where the proceeds are used to finance construction of some kind.
In the United States Financial Services industry, however, a construction loan is a more specific type of venture capital designed for construction and containing features such as interest reserves, where repayment ability may be based on something that can only occur when the project is built. Thus, the defining features of these loans are special monitoring and guidelines above normal loan guidelines to ensure that the project is completed so that repayment can begin to take place.
Lenders will want to know a total monetary amount required for construction, and they’ll also require a line-by-line breakdown of what will happen, when it will happen, how much labor will cost on a day-to-day basis and how much materials will cost, as well as a schedule that contains an estimated completion date.
Construction loans are often extended for developers who are seeking to build something but sell it immediately after building it. In this case, a special appraisal is ordered to attempt to predict the future sales value of the project. The first guideline above, affordability, is usually not used because the owner would immediately attempt to sell the property. However, it is used sometimes for example when a developer is building condominiums, the lender might evaluate whether if the project was changed from condominiums to apartments if the rents received would more than repay the loan each month. (see also equipment finance)
In construction loans funding, cash injection requirements are often higher due to the added risk (the immediate need to sell).
Construction Loans – Repayment
Construction loans are paid off from the proceeds of permanent financing, which in turn is repaid from the cash flow generated by the completed building, and is arranged before the construction loan is disbursed.
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Debt Finance
Debt finance occurs when a firm raises money for working capital or capital expenditures by selling bonds, bills, or notes to individual and/or institutional investors.
A debt is an obligation owed by one party (the debtor) to a second party, the creditor; usually this refers to assets granted by the creditor to the debtor, but the term can also be used metaphorically to cover moral obligations and other interactions not based on economic value. A debt is created when a creditor agrees to lend a sum of assets to a debtor. Debt is usually granted with expected repayment; in modern society, in most cases, this includes repayment of the original sum, plus interest. Debt finance is a means of using anticipated future purchasing power in the present before it has actually been earned. Some companies and corporations use debt as a part of their overall corporate finance strategy.
Debt finance includes both secured loans and unsecured loans. Security involves a form of collateral as an assurance the loan will be repaid. If the debtor defaults on the loan, that collateral is forfeited to satisfy payment of the debt. Most lenders will ask for some sort of security on a loan. Few, if any, will lend you money based on your name or idea alone. In return for lending the money, the individuals or institutions become creditors and receive a promise that the principal and interest on the debt will be repaid.
The most common source of debt finance for start-ups often isn’t a commercial lending institution, but family and friends. When borrowing money from your relatives or friends, have your attorney draw up legal papers dictating the terms of the loan. Why? Because too many entrepreneurs borrow money from family and friends on an informal basis. The terms of the loan have been verbalized but not written down in a contract.
Debt finance can be long-term or short-term. Long-term debt financing usually involves a business’ need to buy the basic necessities, such as facilities and major assets, while short-term debt financing includes debt securities with shorter redemption periods and is used to provide necessities such as inventory and/or payroll. (see equity finance)
Tax deductions are huge attraction for debt financing. In most cases, the principal and interest payments on a business loan are classified as business expenses, and thus can be deducted from your business income taxes. It helps to think of the government as a “partner” in your business, with a 30 percent ownership stake (or whatever your business tax rate is). If you can cut the government out of the equation, then it’s beneficial to your business.
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EBITDA
EBITDA is essentially net income with interest, taxes, depreciation, and amortization added back to it, and can be used to analyze and compare profitability between companies and industries because it eliminates the effects of financing and accounting decisions. This is a non-GAAP measure that allows a greater amount of discretion as to what is (and is not) included in the calculation. This also means that companies often change the items included in their EBITDA calculation from one reporting period to the next.
EBITDA is a form of venture capital which first came into common use with leveraged buyouts in the 1980s, when it was used to indicate the ability of a company to service debt. As time passed, it became popular in industries with expensive assets that had to be written down over long periods of time. EBITDA is now commonly quoted by many companies, especially in the tech sector – even when it isn’t warranted.
A common misconception is that EBITDA represents cash earnings. EBITDA is a good metric to evaluate profitability, but not cash flow. EBITDA also leaves out the cash required to fund working capital and the replacement of old equipment, which can be significant. Consequently, EBITDA is often used as an accounting gimmick to dress up a company’s earnings. When using this metric, it’s key that investors also focus on other performance measures to make sure the company is not trying to hide something with EBITDA.
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Equity Finance
Equity finance refers to the buying and holding of shares of stock on a stock market by individuals and firms.
At the start of a business, owners put some funding into the business to finance operations. This creates a liability on the business in the shape of capital as the business is a separate entity from its owners. Businesses can be considered, for accounting purposes, sums of liabilities and assets; this is the accounting equation. After liabilities have been accounted for, the positive remainder is deemed the owner’s interest in the business.
Typically equity holders receive voting rights, meaning that they can vote on candidates for the board of directors (shown on a proxy statement received by the investor) as well as certain major transactions, and residual rights, meaning that they share the company’s profits, as well as recover some of the company’s assets in the event that it folds, although they generally have the lowest priority in recovering their investment. Equity finance may also refer to the acquisition (see acquisition loans) of equity (ownership) participation in a private (unlisted) company or a startup company. When the investment is in infant companies, it is referred to as venture capital investing and is generally regarded as a higher risk than investment in listed going-concern situations.
Equity Finance – Mutual Funds
The equities held by private individuals are often held as mutual funds or as other forms of collective investment scheme, many of which have quoted prices that are listed in financial newspapers or magazines; the mutual funds are typically managed by prominent fund management firms. This form of structured finance allows individual investors to obtain the diversification of the fund(s) and to obtain the skill of the professional fund managers in charge of the fund(s).
An alternative, which is usually employed by large private investors and pension funds, is to hold shares directly; in the institutional environment many clients who own portfolios have what are called segregated funds, as opposed to or in addition to the pooled mutual fund alternatives. The notion of equity with respect to real estate comes the equity of redemption. This equity is a property right valued at the difference between the market price of the property and the amount of any mortgage or other encumbrance. Equity finance is sometimes referred to as the opposite of debt finance.
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Equipment Finance
Equipment finance is a source of venture capital that lets you hold onto your cash, or working capital, so it can be used for other areas of your business, such as expansion, improvements, marketing or R&D.
Equipment finance can help mitigate the uncertainty of investing in a capital asset your business needs until it achieves a desired return, increases efficiency, saves costs or meets other business objectives. Equipment financing may hedge inflation risk because instead of paying the total cost of equipment up front or with a large down payment in todays dollars, the stream of payments delays your outlay of funds. In addition, either a lease or loan can lock in the rates that exist on the date of the closing. In other words, the finance company absorbs the devaluation of your payments over time due to inflation and other financial risks.
Equipment financing provides funding for companies looking to purchase equipment, but lack traditional funding sources to pay for the purchase. Typically with equipment financing loans, the cost of the equipment is spread out over the course of a payment plan which extends over a number of years. For these business funding types, the equipment is used as collateral to help secure the position of the lender and lower the interest rate on the loan.
Equipment finance is often used by growing companies to purchase necessary equipment, but may also be used by established companies to replace tired equipment or upgrade equipment to remain competitive. Some equipment financing companies require a business history of at least 3-years and rates may vary based on how long the company has been in operation. Tangible assets that are peripheral to a company’s operations but are nonetheless necessary. Trucks to transport materials and toilet paper for customer bathrooms are both examples of equipment. Fixed assets that are acquired as additions or supplements to more permanent assets. Equipment includes lighting fixtures in a building, for example. Equipment, unlike real estate, is generally moveable. (See construction loans).
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Factoring
Factoring is one of a business funding types whereby a business sells its accounts receivable (i.e., invoices) to a third party (called a factor) at a discount.
In “advance” factoring, the factor provides financing to the seller of the accounts in the form of a cash “advance,” often 70-85% of the purchase price of the accounts, with the balance of the purchase price being paid, net of the factor’s discount fee (commission) and other charges, upon collection from the account client. In “maturity” factoring, the factor makes no advance on the purchased accounts; rather, the purchase price is paid on or about the average maturity date of the accounts being purchased in the batch.
Today factoring’s rationale still includes the financial task of advancing funds to smaller rapidly growing firms who sell to larger more creditworthy organizations. While almost never taking possession of the goods sold, factors offer various combinations of money and supportive services when advancing funds.
Factoring is a method used by some firms to obtain venture capital. Certain companies factor accounts when the available cash balance held by the firm is insufficient to meet current obligations and accommodate its other cash needs, such as new orders or contracts; in other industries, however, such as textiles or apparel, for example, financially sound companies factor their accounts simply because this is the historic method of business funding.
The use of factoring to obtain the cash needed to accommodate a firm’s immediate cash flow needs will allow the firm to maintain a smaller ongoing cash balance. By reducing the size of its cash balances, more money is made available for investment in the firm’s growth.
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Hard Money Loans
Hard money loans are typically issued by private investors or companies.
Hard money loans are a specific type of asset based lending through which a borrower receives funds secured by the value of a parcel of real estate. Hard money loans are typically issued by private investors or companies. Interest rates are typically higher than conventional commercial or residential property loans because of the higher risk taken by the lender. Most hard money loans are used for projects lasting from a few months to a few years. Hard money is similar to a bridge loan, which usually has similar criteria for lending as well as cost to the borrowers.
The primary difference is that bridge loans often refers to a commercial property or investment property that may be in transition and does not yet qualify for traditional financing, whereas hard money often refers to not only an asset-based loan with a high interest rate, but possibly a distressed financial situation, such as arrears on the existing mortgage, or where bankruptcy and foreclosure proceedings are occurring.
Hard Money Loans – Qualifying
The qualifying criteria for a hard money loan varies widely by lender and loan purpose. Credit scores, income and other conventional lending criteria may be analyzed. However, most hard money lenders primarily qualify such venture capital based on the value of the real estate being collateralized. Typically, the biggest loan one can expect would be between 65% and 70% of the property value. That is, if the property is worth $100,000, the lender would advance $65,000 – $70,000 against it. This low LTV (loan to value) provides added security for the lender, in case the borrower does not pay and they have to foreclose on the property.
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Mezzanine Finance
Mezzanine financing is a subordinated debt or preferred equity instrument that represents a claim on a company’s assets which is senior only to that of the common shares. Mezzanine finance can be structured either as debt (typically an unsecured and subordinated note) or preferred stock.
Mezzanine capital is often a more expensive venture capital source for a company than secured debt or senior debt. The higher cost of capital associated with mezzanine financings is the result of it being an unsecured, subordinated (or junior) obligation in a company’s capital structure (i.e., in the event of default, the mezzanine financing is only repaid after all senior obligations have been satisfied). Additionally, mezzanine finance, which is usually private placements, is often used by smaller companies and may involve greater overall levels of leverage than issues in the high-yield market; as such, they involve additional risk. In compensation for the increased risk, mezzanine debt holders require a higher return for their investment than secured or more senior lenders.
Mezzanine financing can be completed through a variety of different structured finance based on the specific objectives of the transaction and the existing capital structure in place at the company. The basic forms used in most mezzanine financings are subordinated notes and preferred stock. Mezzanine lenders, typically specialist mezzanine investment funds, look for a certain rate of return which can come from (each individual security can be made up of any of the following or a combination thereof):
Cash Interest A periodic payment of cash based on a percentage of the outstanding balance of the mezzanine financing. The interest rate can be either fixed throughout the term of the loan or can fluctuate (i.e., float) along with LIBOR or other base rates.
PIK Interest Payable in kind interest is a periodic form of payment in which the interest payment is not paid in cash but rather by increasing the principal amount by the amount of the interest (e.g., a $100 million bond with an 8% PIK interest rate will have a balance of $108 million at the end of the period, but will not pay any cash interest).
Ownership Along with the typical interest payment associated with debt finance, mezzanine capital will often include an equity stake in the form of attached warrants or a conversion feature similar to that of a convertible bond. The ownership component in mezzanine securities is almost always accompanied by either cash interest or PIK interest, and, in many cases, by both.
In structuring a mezzanine security, the company and lender work together to avoid burdening the borrower with the full interest cost of such venture capital. Because mezzanine lenders will seek a return of 14% to 20%, this return must be achieved through means other than simple cash interest payments. As a result, by using equity ownership and PIK interest, the mezzanine lender effectively defers its compensation until the due date of the security or a change of control of the company.
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Non-Recourse Debt
A type of loan that is secured by collateral, which is usually property. If the borrower defaults, the issuer can seize the collateral, but cannot seek out the borrower for any further compensation, even if the collateral does not cover the full value of the defaulted amount. This is one instance where the borrower does not have personal liability for the loan.
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Secured Loans
Secured loans can become secured by a contractual agreement, statutory lien, or judgment lien. Contractual agreements can be secured by either a Purchase Money Security Interest (PMSI) loan, where the creditor takes a security interest in the items purchased (i.e. vehicle, furniture, electronics); or, a Non-Purchase Money Security Interest (NPMSI) loan, where the creditor takes a security interest in items that the debtor already owns. Secured loans can be useful. Secured loans are asset based lending in which the borrower pledges an asset as collateral for the loan.
This asset becomes a secured debt owed to the creditor who gives secured loans. The debt is thus secured against the collateral. In some venture capital instances, in the event that the borrower defaults, the creditor takes possession of the asset used as collateral and may sell it to regain some or all of the amount originally lent to the borrower, for example, foreclosure of a home. From the creditor’s perspective this is a category of debt in which a lender has been granted a portion of the bundle of rights to specified property.
If the sale of the collateral does not raise enough money to pay off secured loans, the creditor can often obtain a deficiency judgment against the borrower for the remaining amount. The opposite of secured loans is unsecured debt, which is not connected to any specific piece of property and instead the creditor may only satisfy the debt against the borrower rather than the borrower’s collateral and the borrower. Generally speaking, secured debt may attract lower interest rates than unsecured debt due to the added security for the lender; however, credit history, ability to repay, and expected returns for the lender are also factors affecting rates.
In business funding types, there are two purposes for secured loans. In the first purpose, by extending the loan through securing the debt, the creditor is relieved of most of the financial risks involved because it allows the creditor to take the property in the event that the debt is not properly repaid. In exchange, this permits the second purpose where the debtors may receive loans on more favorable terms than that available for unsecured debt, or to be extended credit under circumstances when credit under terms of debt finance would not be extended at all. The creditor may offer secured loans with attractive interest rates and repayment periods for the secured debt.
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Trade Finance
Trade financing relates to international trade.
The term trade finance means financing a trade. For a trade to happen, we have a seller to sell the goods and we have a buyer to buy the goods. Various intermediateries such as (banks), (financial institutions) can facilitate the trade by financing the trade. Trade finance refers to financing international trading transactions. In this financing arrangement, the bank or other institution of the importer provides for paying for goods imported on behalf of the importer.
While a seller (the exporter) can require the purchaser (an importer) to prepay for goods shipped, the purchaser (importer) may wish to reduce risk by requiring the seller to document the goods that have been shipped. Banks may assist by providing various forms of support. For example, the importer’s bank may provide a letter of credit to the exporter (or the exporter’s bank) providing for payment upon presentation of certain documents, such as a bill of lading. The exporter’s bank may make a loan (by advancing funds) to the exporter on the basis of the export contract.
Other forms of trade finance can include documentary collection, trade credit insurance, export factoring, and forfaiting. Some forms are specifically designed to supplement traditional trade financing. In many countries, trade financing is often supported by quasi-government entities known as export credit agencies that work with commercial banks and other financial institutions.
Since secure trade finance depends on verifiable and secure tracking of physical risks and events in the chain between exporter and importer,the advent of new methodologies in the information systems world has allowed the development of risk mitigation models which have developed into new advanced finance models. This allows very low risk payment advances to exporters to be made,while preserving the importers normal payment credit terms and without burdening the importers balance sheet. As the world progresses towards more flexible, growth oriented funding sources post the global banking crisis,the demand for these new methodologies has increased dramatically amongst exporters, importers and banks.
Trade Financing – Products & Services
The following are the most famous products / services offered by various financial institutions in trade financing.
• Letters of Credit
It is a brief undertaking / promise given by the buyers financial institution to the seller / seller’s financial institutions that, it guarantees the payment to seller / seller bank, on behalf of the buyer. In other words, if the buyer defaults the payment, it is the responsibility of the buyers bank to make the payment. This undertaking can be given either in writing or through authorized electronic medium.
• Bill Collection
It is a major service offered in banks. Seller’s Bank collects the payment proceeds for the exported goods, on behalf of the goods from the buyer’s bank.
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INVESTMENT FUNDING
International Finance
International finance (also referred to as international monetary economics or international macroeconomics) is the branch of financial economics broadly concerned with monetary and macroeconomic interrelations between two or more countries.
International finance examines the dynamics of the global financial system, international monetary systems, balance of payments, exchange rates, foreign direct investment, and how these topics relate to international trade. Sometimes referred to as multinational finance, international finance is additionally concerned with matters of international financial management. Investors and multinational corporations must assess and manage international risks such as political risk and foreign exchange risk, including transaction exposure, economic exposure, and translation exposure.
International Finance – International Trade
International trade is the exchange of capital, goods, and services across international borders or territories. In most countries, such trade represents a significant share of gross domestic product (GDP). While international trade has been present throughout much of history (see Silk Road, Amber Road), its economic, social, and political importance has been on the rise in recent centuries.
Industrialization, advanced transportation, globalization, multinational corporations, and outsourcing are all having a major impact on the international trade system. Increasing international trade is crucial to the continuance of globalization. Without international trade, nations would be limited to the goods and services produced within their own borders.
International trade is, in principle, not different from domestic trade as the motivation and the behavior of parties involved in a trade do not change fundamentally regardless of whether trade is across a border or not. The main difference is that international trade is typically more costly than domestic trade. The reason is that a border typically imposes additional costs such as tariffs, time costs due to border delays and costs associated with country differences such as language, the legal system or culture.
Another difference between domestic and international trade is that factors of production such as capital and labor are typically more mobile within a country than across countries. Thus international trade is mostly restricted to trade in goods and services, and only to a lesser extent to trade in capital, labor or other factors of production. Trade in goods and services can serve as a substitute for trade in factors of production.
Instead of importing a factor of production, a country can import goods that make intensive use of that factor of production and thus embody it. An example is the import of labor-intensive goods by the United States from China. Instead of importing Chinese labor, the United States imports goods that were produced with Chinese labor. One report in 2010 suggested that international trade was increased when a country hosted a network of immigrants, but the trade effect was weakened when the immigrants became assimilated into their new country.
International trade is also a branch of economics, which, together with international finance, forms the larger branch of international economics.
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Joint Ventures
joint venture (JV) is a business agreement in which the parties agree to develop, for a finite time, a new entity and new assets by contributing equity. They exercise control over the enterprise and consequently share revenues, expenses and assets. There are other types of companies such as JV limited by guarantee, joint ventures limited by guarantee with partners holding shares.
A joint venture takes place when two parties come together to take on one project. In a joint venture, both parties are equally invested in the project in terms of money, time, and effort to build on the original concept. While joint ventures are generally small projects, major corporations also use this method in order to diversify. A joint venture can ensure the success of smaller projects for those that are just starting in the business world or for established corporations. Since the cost of starting new projects is generally high, a joint venture allows both parties to share the burden of the project, as well as the resulting profits.
Since money is involved in a joint venture, it is necessary to have a strategic plan in place. In short, both parties must be committed to focusing on the future of the partnership, rather than just the immediate returns. Ultimately, short term and long term successes are both important. In order to achieve this success, honesty, integrity, and communication within the joint venture are necessary.
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Business Funding Glossary
Assets
Anything of value. Any interest in real or personal property which can be appropriated for the payment of debt.
Bad Debt
A debt that is not collectible and is therefore worthless to the creditor.
Balance Sheet
Financial statement presenting measures of the assets, liabilities and owner’s equity or net worth of business firm or nonprofit organization as of a specific moment in time.
Bridge Loans
Bridge loans provide temporary financing until more permanent financing is available.
Business Plan
Business plans describe an organization’s current status and plans for several years into the future. It generally projects future opportunities for the organization and maps the financial, operations, marketing and organizational strategies that will enable the organization to achieve its goals.
Capital
Broadly, all the money and other property of a corporation or other enterprise used in transacting its business.
Capitalization
Long-term debt, preferred stock and net worth. The loan capital of a community development loan fund; includes that which has been borrowed from and is repayable to third parties as well as that which is earned or owned by the loan fund (i.e. “permanent capital”).
Capital Markets
Those financial markets, including institutions and individuals, that exchange securities, especially long-term debt instruments.
Cash Flow Financing
Short-term loan providing additional cash to cover cash shortfalls in anticipation of revenue, such as the payment(s) of receivables.
Collateral
Assets pledged to secure the repayment of a loan.
Cost of Capital
This is the rate of return required by a firm’s capital investors in order to maintain the current market valuation of their claim on the business.
Covenant
An agreement or promise to do or not to do a particular thing; to enter into a formal agreement; a promise incidental to a deed or contract. The following are functional objectives guiding most covenants: full disclosure of information, preservation of net worth, maintenance of asset quality, maintenance of adequate cash flow, control of growth, control of management, assurance of legal existence and concept of going concern, provision for lender profit or program goals.
Current Asset
Assets that will normally be turned into cash within a year.
Current Liability
Liability that will normally be repaid within a year.
Current Ratio
Current assets divided by current liabilities — a measure of liquidity. Generally, the higher the ratio, the greater the “cushion” between current obligations and a firm’s ability to meet them.
Debt
An amount owed for funds borrowed. The debt may be owed to an organization’s own reserves, individuals, banks, or other institutions. Generally, the debt is secured by a note, bond, mortgage, or other instrument that states repayment and interest provisions. The note, in turn, may be secured by a lien against property or other assets.
Debt Service
Amount of payment due regularly to meet a debt agreement; usually a monthly, quarterly or annual obligation.
Debt Service Cover Ratio [DSCR]
Ratio of the operating cash flow over the principal and interest on the loan, calculated during each year of operating life of the SPV. This indicator is used to verify that the financial resources generated by the project (numerator) can service the debt toward lenders in every year of operations (denominator).
The higher this ratio is, the easier it is to obtain a loan.
Debt Service Reserve
Term used to refer to cash reserves set aside by a borrower, either by internal policy or lender covenant, to repay debt in the event that cash generated by operations is insufficient.
Default
A failure to discharge a duty. The term is most often used to describe the occurrence of an event that cuts short the rights or remedies of one of the parties to an agreement or legal dispute, for example, the failure of the mortgagor to pay a mortgage installment, or to comply with mortgage covenants.
Delinquent
In a monetary context, something that has been made payable and is overdue and unpaid,
Due Diligence
Refers to the task of carefully confirming all critical assumptions and facts presented by a borrower. This includes verifying sources of income, accuracy of financial statements, value of assets that will serve as collateral, the tax status of the borrower and any other material facts presented by the borrower.
Endowment or Trust
A fund that contains assets whose use is restricted only to the income earned by these assets.
Equity
The value of property in an organization greater than total debt held on it. Equity investments typically take the form of an owner’s share in the business, and often, a share in the return, or profits. Equity investments carry greater risk than debt, but the potential for greater return should balance the risk.
Equity Participation
An ownership position in an organization or venture taken through an investment. Returns on the investment are dependent on the profitability of the organization or venture.
Fund Balance
Net worth in a nonprofit organization; total assets minus total liabilities.
General Recourse
Rights to demand payment from the general assets of the debtor, without seniority in access to any specific assets.
Guaranteed Loan
A pledge to cover the payment of debt or to perform some obligation if the person liable fails to perform. When a third party guarantees a loan, it promises to pay in the event of a default by the borrower.
Hurdle Rate
The minimum rate of return on a project or investment required by a manager or investor. In order to compensate for risk, the riskier the project, the higher the hurdle rate.
Interim Financing
Short-term loan to provide temporary financing until more permanent financing is available.
Intermediaries
Non- or for-profit institutions that have specialized lending capacities. They obtain capital in the form of equity and low interest loans from a variety of sources, including foundations and other funders, to form a “lending pool.” They then serve as “wholesalers” who process large numbers of small loans or investments. This “economy of scale” often allows intermediaries to be more efficient than a foundation or funder could be if it considered each investment individually. Also, intermediaries often develop expertise in a particular field or region that foundations or funders cannot afford to develop. In the context of this study, non-financial intermediaries include community foundations and financial intermediaries include credit unions, venture capital and loan funds, banks, etc.
Internal Rate of Return [IRR]
The interest rate that make the Net Present Value (NPV) of a project’s positive operating cash flow equal to the net present value of its negative operating cash flows. In a project finance deal, three IRR’s can be calculated: (i) Equity IRR, (ii) Lenders (senior or subordinated) IRR, and (iii) Project IRR.
IRR is a percentage return measure giving the economic yield on the capital investment to the investor. If the IRR is greater (positive) than the firm’s minimum required rate of return (i.e. cost of capital) then the capital investment is worthwhile (e.g. positive return on investment).
Leverage
Using long-term debt to secure funds for an organization. In the social investment world, often refers to financial participation by other private, public or individual sources.
Liabilities, Total Liabilities
Total value of financial claims on a firm’s assets. Equals total assets minus net worth.
Limited Liability
Limitation of shareholders’ losses to the amount invested.
Limited Recourse
Rights only to specifically stipulated assets to satisfy an unpaid debt.
Line of Credit
Agreement by a bank that a company may borrow at any time up to an established limit.
Linked Deposit
A deposit in an account with a financial institution to induce that institution’s support for one or more projects. By accruing no interest or low interest on its deposit, a foundation essentially subsidizes the interest rate of the project borrowers.
Loan Agreement
A written contract between a lender and a borrower that sets out the rights and obligations of each party regarding a specified loan.
Loss Reserves
That portion of a fund’s earnings or permanent capital designated by the board of directors as a reserve against possible loan losses and, as such, unavailable for lending purposes. Generally accepted accounting principles governing for-profit and regulated financial institutions require that loan loss expense be deducted as an annual expense on an accrual basis and that the loan loss reserve be shown as a contra asset reducing loan assets. To date, no accounting convention has been established to govern loan loss reserve accounting for unregulated nonprofit institutions. The technical treatment is to establish the reserve through periodic charges against earnings, and actual losses, when and if incurred, and are charged against the reserve. For balance sheet purposes a loan loss reserve (should) be shown as a deduction from the loan portfolio to suggest that its true economic value should be reduced by the estimated loss exposure.
Market Rate
The rate of interest a company must pay to borrow funds currently. Program-related investments generally are offered at below market rates or at no interest rate.
Negative Covenants
Statements of actions or events of the borrower must prevent from occurring or existing, for example, additional borrowing without the lender’s consent.
Net Present Value [NPV]
Present Value of cash flows generated by a project. This is an indicator of the incremental wealth produced by the initiative. A positive net present value demonstrates the project’s capacity to generate enough cash to pay off initial expenses, compensate capital utilized in the initiative, and have residual resources for other uses.
NPV of an investment represents the increase in the cash value of the investor – only investments which offer a positive NPV should be undertaken.
The ratio of NPV to capital outlays is known as Profitability Index or NPC Index.
Normally, if a project has a positive NPV it will have an IRR in excess of the company’s minimum required rate of return.
Net Working Capital
Current assets minus current liabilities.
Net Worth (Fund Balance in nonprofit. organizations)
Total assets minus total liabilities. Aggregate net value of the organization.
Opportunity Cost
The potential benefit that is foregone from not following the best (financially optimal) alternative course of action.
Payback Period
Moment in time when project Outflows and Inflows are equal. Once the drawdown period is over (which usually coincides with the construction phase), the payback period is inversely proportional to the quantity of the operating cash flows generated by the project.
Portfolio
A combination of assets held for its investment benefits, including financial and non-financial returns. The asset mix is usually varied in kind and size to maintain an acceptable level of risk and return.
Principal
In commercial law, the principal is the amount that is received, in the case of a loan, or the amount from which flows the interest.
Profitability Index
An index that attempts to identify the relationship between the costs and benefits of a proposed project through the use of a ratio calculated as:
PI = PV of Future Cash Flow / Initial Investment
A ratio of 1.0 is logically the lowest acceptable measure on the index. Any value lower than 1.0 would indicate that the project’s PV is less than the initial investment. As values on the profitability index increase, so does the financial attractiveness of the proposed project.
Program-Related Enterprise
A business or enterprise designed to promote the social purpose goals of an organization as well as generate revenue. Among nonprofits, products and services are usually, but not exclusively, identified with the purpose of the organization. Activities can range from fee-for-service charges to full-scale commercial ventures.
Program-Related Investment
Broad, functional definition: A method of providing support to an organization, consistent with program goals involving the potential return of capital within an established time frame. In the context of this study, program-related investments include loans, loan guarantees, equity investments, asset purchases or the conversion of asset(s) to charitable use, linked deposits, and, in some cases, recoverable grants.
Promissory Note
Promise to pay. Written contract between a borrower and a lender that is signed by the borrower and provides evidence of the borrower’s indebtedness to the lender.
Receivables
Accounts receivable; an amount that is owed the business, usually by one of its customers as a result of the ordinary extension of credit,
Recourse
Refers to the right, in an agreement, to demand payment from the person who is taking on an obligation. A full recourse loan refers to the right of the lender to take any assets of the borrower if repayment is not made. A limited recourse loan only allows the lender to take assets named in the loan agreement. A non-recourse loan limits the lender’s rights to the particular asset being financed — an approach that is common in home mortgages and other real estate loans.
Recoverable Grants
Funds provided by a philanthropist to fulfill a role similar to equity. A recoverable grant may include an agreement to treat the investment as a grant if the enterprise is not successful, but to repay the investor if the enterprise meets with success.
Restructure
A revision of a financial agreement that alters the conditions or covenants of the original agreement. For example, parties may agree to restructure a loan agreement, easing the payment schedule, when a borrower is delinquent or otherwise faces default on a loan.
Roll Over
Prior to or at the time of the maturity of an investment or loan, the interested parties agree to continue to carry over the investment or loan for another, successive period of time.
Security
A pledge made to secure the performance of a contract or the fulfillment of an obligation. Examples of securities include real estate, equipment stocks or a co-signer. Mortgages are a form of security with strong legal standing, because they are publicly registered following a formal legal procedure. A mortgage gives the lender holding a mortgage security the right to reclaim the asset being financed, if repayment is not made.
Senior Debt
Debt that must be repaid before subordinated debt receives any payment in the event of default.
Subordinated Debt (Junior Debt)
Debt over which senior debt takes priority. In the event of bankruptcy, subordinated debt-holders receive payment only after senior debt is paid in full. A subordination of security interest in property allows another creditor to have the rights to the proceeds of the sale of that property before the claim of the subordinated creditor.
Term
Refers to the maturity or length of time until final repayment on a loan, bond, sale or other contractual obligation.
User
A non- or for-profit entity that receives a program-related investment directly from a funder for use in its programs or ventures.
Warranties
Statement attesting that certain statements are true. For instance, the borrower may warrant that it is a corporation, that it is entering into the agreement legally and that financial statements supplied to the bank are true.
Water Fall Distribution
Hierarchy of distribution of an equity fund. This specifies the order of distribution to investors when their investments are sold. For instance, general investors can only receive their share of the fund after preferred investors are given their corresponding shares.
Working Capital
Technically, means current assets and current liabilities. The term is commonly used a synonymous with net working capital. The term often also is used to refer to all short-term funding needs for operations (excluding debt service and fixed assets). A company’s investment in current assets that are used to maintain normal business operations. Net working capital, which is the excess of current assets over current liabilities is also interchangeable with working capital. Both reflect the resources in circulation to meet operating needs and obligations as they come due.
Write Off
When an investment, such as a loan, becomes seriously delinquent or in default and is determined to be uncollectible, the lender may choose to charge the outstanding investment amount as an expense or a loss.
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See also; Project Financing Theory & Practice
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See also; Hospitality & Mixed-Use Projects
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See also; Blog – Project Financing
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