Terminology Demystified

DEFINITION:  Investments made into companies, organizations, and funds with the intention to generate social and/or environmental impacts alongside a financial return. Impact investments can be made in both emerging and developed markets, and target a range of returns from below market to market rate, depending upon the circumstances.  Article

The growing impact investment market provides capital to address the world’s most pressing challenges in sectors such as sustainable agriculture, clean technology, microfinance, and affordable and accessible basic services including housing, healthcare, and education.

Broadly, there are two categories of Impact Investors, those who put financial returns first (where social/environmental impacts ride along) and those who put social/environmental returns first, and are thus willing to accept below-market financial returns or offer other accommodation to fulfill their investment thesis.  In3 fits into both of these categories depending on the sector, location, and risks.

Sustainable Investing

DEFINITION:  Industry term used to describe investments intended to generate both social/environmental and financial returns in all forms of investments including debt and equity in both public and private markets.

Sustainable Development 

Triple Bottom Line (3BL or TBL)

DEFINITION:  The 3 P’s of “people, planet, profit” and a guiding influence for much of the impact/sustainable development and investing ecosystem.  Sometimes projects or ventures focus on just 2 of 3 bottom lines, so-called Double Bottom Line or DBL.  That means there is less or no consideration of either the environmental aspects or social impacts, but such investments still uphold financial fundamentals — the original “bottom line.”

For some players outside this impact/sustainability/ESG ecosystem, this is all that purportedly matters — making money, rationalized in countless ways and excuses (“a financially strong organization will outlast COVID-19”, which is not untrue, but needlessly narrow-minded, as health and the environment and social sustainability are all inseparable at the end of the day).  Admittedly, the vast majority of companies and even projects only consider the financial bottom line, based on observed behavior, which will continue to evolve until this more inclusive model of embracing a wider set of criteria becomes the New Normal.  Some would argue we are now well down that road as of the 2020 pandemic.

We often hear the phrase “triple bottom line performance” voiced as the goal and a key concern or indicator while impact investors evaluate prospect deals to pinpoint risk/reward. This is why 90%+ of all impact investors (according to the GIIN’s multi-year surveys) are obsessed with measuring and monitoring the social and environmental impacts of their investments.

Not unlike the physician’s credo, and Star Trek Prime Directive, “first, do no harm” needs to gain wider adoption, which can also be enforced “bottom up” by our own choices while shopping, vendors and suppliers, business partners, and capital investments.

Environmental, Social, Governance (ESG)

DEFINITION:  ESG factors are generally viewed in how business decisions impact customers, employees, suppliers, shareholders / investors, and the environment. ESG factors offer portfolio managers added insight into the quality of a company’s management, culture, risk profile and other characteristics. There is growing evidence that suggests that ESG factors, when integrated into investment analysis and decision making, may offer investors potential long-term performance advantages.  Performance aside, it turns out that companies that take these factors into account, usually by measuring their own improvements, tend to be better managed companies.

There are many similarities between Impact Investing and ESG investing; is Impact Investing a subset of ESG investing or the other way around?  For a comparison of Impact Investing, ESG investing and SRI (defined next), go here.  Investopedia seems to be confusing Impact Investing with philanthropy.

Socially Responsible Investing (SRI)

DEFINITION:  A typical SRI approach uses “negative screening” to rule out investments in industries or companies that produce or sell harmful products or such as tobacco, alcohol, pornography, gambling, fossil fuels, and weapons. These companies may also operate in countries that pollute or violate human rights. Also referred to as “values-based investing” where the investor has unique considerations that reflect their hierarchy of values beyond financial goals.

Mission-Related Investing (MRI)

DEFINITION:  Investments are clearly aligned with the specific mission and social beliefs of the organization. For example: the support of small businesses in a low-income neighborhood by a local community foundation.

Program-Related Investing (PRI)

DEFINITION:  A form of MRI with specific IRS definition associated with private, non-operating foundations. PRIs are the loans or capital investments a private foundation makes to further its charitable purposes. PRIs can be used to satisfy a foundation’s five percent spending requirement, however, they cannot be used to influence legislation or political campaigns.

Natural Climate Solutions (NCS)

DEFINITION:  Natural climate solutions are conservation, restoration and improved land management actions that increase carbon storage or avoid greenhouse gas emissions in landscapes and wetlands across the globe. more

Funding via In3’s Completion Assurance [Guarantee] Program (CAP)

DEFINITION: A novel technique for providing access to impact projects that would otherwise go unfunded, typically, or at best would take a far greater outlay of time and energy (and owner cash) to piece together a set of equity partner “sponsors” and unfortunately, struggle with satisfying lender conditions, with no roadmap to make the process at all predictable, streamlined or efficient.  Instead, CAP opens quite a few new, innovative options for securing mid-market Sustainable/Impact/Clean/Renewables project funding at quite competitive terms.  “Faster, easier, better.”  Tools at CAP Proposal Builder™

Circular / Clean / Sustainable Economy

DEFINITION:  Circular/sustainable economies promote the use of zero waste strategies, recovered materials (“technical nutrients”), renewable materials (“biological nutrient”) and clean, renewable energy, food systems, water, heading toward sustainable transportation/mobility, greener buildings, etc., often using better designs and business models to “close the loop” on waste, creating cycles of production that naturally regenerate and further improve the productive capacity of those systems, such as no till practices in agriculture that regenerate healthy topsoil, or services that deliver the value of a product without consuming/wasting that product (such as take-back approaches to renting or leasing a thing rather than owning the thing outright), a type of sustainable consumption practice.  Other examples:

• LED lighting “as a service,” with zero up-front costs to the customer, using the energy cost savings of more efficient LEDs to pay for the upgrade.
• Waste-to-value strategies also tend to incorporate the efficient and effective recycling or “upcycling” of materials, as well as waste heat (energy) recovery.

There are countless additional examples of these profitable strategies across diverse industries, often demonstrating even more sustainable profit streams due to value chain advantages and the inherent innovative designs.

Financial Terms Glossary

APR — Annual Percentage Rate (as a %) refers to the annual rate of interest charged to borrower and paid to investors/lenders.  The actual costs of those funds over the terms of the loan or income earned on an investment.  As usually quoted, APR does not include any fees or related costs.  With a Financial Guarantee we do not charge an application fee or other up front fees.  More at How We Work (fundamental FAQs).

Asset-Backed Lending:  Most project finance is asset-backed in the sense that the project itself is comprised of various types of tangible (physical) assets, such as buildings, equipment, etc., used as a pledge of collateral for the Senior Loan (see also “Senior Debt” below) via a lien against some or all of the project’s assets.  Such “collateralized credit facilities” typically offer high security but marginal cashflows.

In3’s CAP funding does not use this approach; we offer mezzanine debt and equity without an asset-backed position once the project reaches commercial operation.  We also do not request a loan guarantee, the traditional instrument used to enhance the borrower’s credit and ensure debt repayment, commonly used with limited or no recourse loans.  See below for more about Recourse or contrast with Cash Backed.

Aval:  A “stamp” or “seal” that provides some degree of registration and validation (within certain assume parameters) when added to a debt obligation document, such as a Note (defined below). See this term used in the context of an Avalized Promissory Note (AvPN), one of several qualifying Completion Assurance Guarantees (separate topic). AvPN intro article

Bank Guarantee (BG):  A type of financial instrument that constitutes a promise, in the form of a contingent obligation, with diverse uses and formats, mostly outside the United States (ref), and quite similar to a Standby Letter of Credit (SbLC or SLOC), defined below.  BG verbiage (wording) refers to the specific text that sets forth the terms of the instrument.  Mostly used in international business transactions, such as (in the case of CAP funding) as security for project finance.

Some forms of a BGs and SbLCs include Financial Guarantees, Performance Guarantees, Payment Guarantees, or Demand Guarantees.  Such guarantees from a reputable institution can help you establish business relationships, increase your access to cash flow and capital, protect your business from losses, enable either domestic or international business opportunities, including Project Funding and (with an SbLC or SLOC) import-export Trade Finance.  More under “Demand Guarantee” or Standby Letters of Credit”. 

Beneficiary: In Trade Finance (not what we’re mainly doing), the Beneficiary is the party who receives payment from a transferable, “Documentary” Letter of Credit (DLC) or similar bank-involved guarantee. With project finance, however, instead of a seller or exporter using a cash-based Letter of Credit (because the beneficiary wants more security), a Standby Letter of Credit (SbLC or SLOC) lists the funder as Beneficiary, and in the case of CAP funding, the financial instrument can be leveraged as completion security.  Once the project construction completes, the guarantee is allowed to expire and is removed or returned.  It is not “cashed” or used to pay anyone, such as is done in Trade Finance, to back up payment by the buyer. Instead, the instrument sits during construction and ensures that the parties work together to complete and deliver the project. The Beneficiary is the funder that transfers funds to the project owner’s bank account to buy components, build and commission the project.

Cash Backed [guarantee]:  This phrase is a bit of a misnomer; it does not mean that a guarantee is necessarily issued using cash as collateral.  Some guarantees do not require collateral at all, cash or otherwise, depending on the applicant and involved bank, but a bank-involved guarantee is “cash backed” only in the sense that the bank backstops the instrument as cash in the event that a legitimate claim is made against it, in which case the Beneficiary would be entitled to receive cash.  CAGs (see next item) can be issued against assets — whatever the involved banker is willing to accept — or without collateral, in some cases, or against cash, though this latter scenario would needlessly tie up cash during the life of the instrument. See “Understanding the Purpose and Benefits of a Banker’s Guarantee.”

Completion Assurance Guarantee:  a legal instrument (an official letter) that assigns some or all of the responsibility for an investment, a loan, or in our case with In3’s Completion Assurance [Guarantee] Program (CAP), formerly CGP, completion of project construction and commissioning, to another party in case of default (breach of contract). more

Completion Assurance [Guarantee] Program (CAP):  In3’s flagship approach to making advantageous project financing available to as wide a range of developers as possible, offering up to 100% financing (combining mezzanine debt and an equity “kicker”), at any stage, almost any sector (so long as it either has social/environmental benefits, or at least does not harm), located almost anywhere, and much more quickly than traditional, mid-market project finance.  Check out recorded webinar introduction or this intro article

Capital Guarantor: A party that brings a guarantee for another.  The guarantor promises to “stand for” or “back” a debt or other obligation contracted by the original party if the original party fails to perform according to a contract.  Under In3’s CAP, the required performance is completing construction and commissioning the project.
Click for a Comparison of various types of Financial Guarantees that can be used for the In3’s funding program.

Cash Flow: The total amount of money being transferred into and out of a business, especially as affecting liquidity.

Capital Stack: A description of the totality of capital invested in a project, including pure debt, convertible debt (sometimes called “quasi equity”), equity, or a hybrid of these. more

Debt Service Coverage (DSC) or DSC Ratio (DSCR): the amount of free cash available to repay a loan (called “debt service”) at any given point.  DSCR is a ratio of income to principal and interest payments, an based on cash flow. A DSCR of 1 means that there is roughly equal amounts or money coming in and going out.  Some use “Cash Available for Debt Service” (CADS), instead.  Either way, In3 CAP funding does not use this, which can be confusing to bankers or others with a traditional funding model in mind.

Demand Guarantee:  A type of financial guarantee used (in the case of CAP funding) for project finance under well-proven international rules and standards designed to balance the legitimate interests of all parties.  The most widely used and proven such rules are the Uniform Rules for Demand Guarantees (URDG), International Chamber of Commerce publication number 758.  Resources to quickly understand this lesser-known area of finance:

• Learn about why URDG is the definitive standard, or order ICC’s eBook at URDG ICC 758
• Download In3’s 4-page whitepaper (part of our FAQ series)
• Visit our KnowledgeBase or related topics.
• In3’s Impact Guarantee Fund™ (IGF) also conducts periodic MasterClasses with extensive training materials for finance professionals.  Contact us for details.

Drawdown Schedule:  See “Sources & Uses” below.

Fixed Rate Loans: A debt obligation with a constant interest rate throughout the term of the loan.

Float: Allowing the rate to vary with changes in market conditions.

Full Leverage Loans:  See “Leveraged Loans” below.

Guarantee or Guaranty:  See “Completion Assurance Guarantee”, above.

Guarantor: A party promises to honor a debt or perform an obligation contracted by the original party if the original party fails to pay or perform according to a contract.  The guarantor can be the developer, a sponsor (such as an EPC firm or General Contractor hired for the project) or a third party such as a bridge lender, impact investor of family office.

Instrument (banking): An instrument is a means by which something of value is transferred, held, or accomplished. For project finance, it usually refers to a legal document with which to store or transfer implied value or obligations.
• A financial instrument is a tradable or negotiable asset, security, or contract.
• Legal instruments may contain binding terms, rights, and/or obligations.

International Accounting Standards (IAS) defines financial instruments as “any contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another entity.”  Any asset can be considered a financial instrument, and instruments can be debt or equity (representing a share of future repayment) or ownership.  An instrument, in essence, is a type of contract or medium that serves as a vehicle for an exchange of some value between parties.

IRR:  The Internal Rate of Return (IRR) is an effective measure of the projected capital efficiency (technically, in relative terms of capital efficiency — how much money is used versus the financial upside measured as “rate of return”).  IRR is calculated as the discount rate that makes the net present value (NPV) of a project investment equal to zero. In other words, it is the expected compound annual rate of return that will be earned on a project or investment. We look for IRRs at least on par with standards for a given project’s industry (more).  If well above or below, expect questions.

Letters of Credit are most often used for international trade, but they are also helpful for domestic or international transactions like construction, renovation or expansion projects.  There are several types of LCs, including mainly Documentary for trade transactions or Standby for project financing.  A Standby Letter of Credit (SbLC, see definition below) is essentially the same as a Bank Guarantee in the US, though US banks do not allow BGs and instead expect SbLCs.  The sending bank communicates directly with a receiving/funding bank, both of which act as “disinterested” third parties. The bank doesn’t take anybody’s side, and funding bank releases funds per a pre-approved monthly draw schedule after certain conditions are met, per In3 CAP funding’s pre-qualification process.

Leveraged Loans:  Either “fully leveraged” or “full leverage” loans are considered higher risk than when part of the new money (“unexpended” cash) comes from an equity investor or other sources, such as co-senior debt, co-investors, or simply diverse forms (asset classes) in the capital stack.  This is what In3 offers, in fact, all of In3’s options for project finance are presently capable of using 100% leverage on a standalone basis.  They also can be used in combination, bespoke to the situation at hand.  For more on how the various In3 funding Programs can accommodate 100% funding, see In3CAP and the Cost of Capital.

Levelized Cost of Energy:  LCOE is the average net present cost of energy generation for a given plant over its lifetime.  LCOE provides greater accuracy when appraising and benchmarking the true costs of energy projects. LCOE is expressed in cents-per-kilowatt- hour (if US currency, then $0.xx/kWh), and takes into account not only the capital cost of building a project, but also the operating and maintenance expenses incurred (O&M), often defined in long-term power purchase agreements).  As LCOE does not include the profit side (usually expressed as IRR, defined above), LCOE is often not as relevant to investors or lenders, but still an important indicator of how the type of energy production (especially geothermal, small hydro, wave, tidal, WTE) compares to other types.  LCOEs are well-established for solar and wind power, for example, where the only question after accounting for all costs and site-specific implications is usually year-on-year production changes, typically presumed performance degradation, an area of notorious rosy underestimation.  Most renewable energy plants underperform relative to their pro forma estimates; be sure not to fall into that trap.

To illustrate this point, if the financials show 0% escalator/degradation, then LCOE and “Year-One COE” would be the same.  To avoid that unreality, ask and account for “what will happen to performance and financial results over time?” and document those assumptions, including the local tax venue, the duration of any incentives, market forces (competition or breakthrough innovations that could result in price pressures after any long-term offtake agreements expire), the “terminal value” (what happens once the assets are decommissioned, including any residual value or cost of recycling the hardware) … this is rocket science by a different name. :>)

Keep it simple, if possible.  LCOE must reflect the tariff rate, if any, that is necessary to achieve the project equity investor’s required after-tax rate of return (equity IRR or eIRR), taking into account all applicable incentives and any market value of production assumed after the tariff expires and before the end of the project’s useful life.

LIBOR: London Interbank Offered Rate — what banks used as a reference for lending to each other, but which has been replaced by SONIA (definition | more on why) as of January 2022. The US government also publishes various Treasury Rates (click for the historical “yield curve”), which parallels SONIA, together the two main indicators. What happened to LIBOR?

LTV Ratio: Loan-to-value, a comparison of the value of the loan to the value of the collateral provided, which serves as one assessment of lending risk, and often a determinant of interest rates.  In3 also uses LTV to describe the amount of completion assurance guarantee coverage relative to the total funding requested.  For a $100M loan, an LTV of 80% would mean a financial guarantee of $80M was provided, thus more favorable terms would be available due to this lower-risk LTV.  A higher risk LTV would be 50%, for example, and if the APR remained constant, we would ask for a greater equity stake.

Mid-Market [project finance]: the Middle Market of project finance typically includes projects with budgets of at $10 million up to $750 million or more. Most of the capital is geared toward larger projects because transaction costs are roughly the same for a $5 million project as for a $500 million one. There is no universally accepted definition of the middle market, but our sweet spot is in the range of $50M-$700M per project, with dry powder capacity into the US$ billions range.

MT-nnn:  SWIFT “message type” where the three numbers that follow refer to the exact message as categorized within the SWIFT system.  For example, MT-760 is a dedicated message type for transmitting on Bank Guarantees, Standby Letters of Credit and Documentary Letters of Credit on a bank-to-bank basis.  Compare that to MT-799, a type of bank-to-bank text message used in a number of communications, including “pre-advice” sent ahead of MT-760.

Note:  Short for “Promissory Note” (PN), a written promise to pay a debt under the conditions defined in the document. A commercial PN is a document that gives the parameters of the debt instrument and legally obligates the borrower to pay the debt under certain terms and conditions defined in the Note. In3 also uses PNs as bespoke financial/completion assurance guarantees with the support of a bank’s “aval” (intro article).

Pro Forma Financial Model or Financial Statement — A pro forma financial statement leverages hypothetical data or assumptions about future values to forecast performance over a period that hasn’t yet occurred.  The cornerstone of financial accounting, such modeling is widely applicable to existing companies, new or “greenfield” projects, or any depiction of future performance based on transparent assumptions. In3 uses a proprietary, US GAAP or IFRS toolset for these projections, as do many investors, who often have their own, proven and familiar methods, built on MS Excel spreadsheets that are known to reflect standard accounting rules and principles.  More

Project Finance — see definition at in3capital.net/project-finance

Project IRR (unlevered) vs. Equity IRR (unlevered):  The overall project IRR as opposed to the portion of ROI that is levered by debt, known as Equity IRR, or eIRR.  Unlevered (overall) project IRR is the more meaningful indicator of capital efficiency, as eIRR measures are largely subjective, based on factors like long-term disposal value (also called “terminal value”) and whether or not profits or cashflows are shared.

Recourse (“non-recourse” or “limited recourse”) Loans:  Recourse is what gives the lender rights if the borrower is unable to satisfy the debt obligation. Recourse refers to the lender’s legal right to collect in the event of default. Limited recourse is a type of loan in which the lender has limited or no claim against the parent company if the collateral (if pledged) is insufficient to repay the debt obligation. More

RWA Letter:  A bank or corporation issues RWA letters to express that they are “ready, willing and able” to enter an undertaking or perform a specific task, related to a financial transaction.  RWAs are effectively a Letter of Intent (LOI) where the future action is contingent upon other factors.  More

Senior Debt or Mortgage: Senior Debt involves a lien against property or other assets used a security and credit enhancement.  A Mortgage is a written document evidencing the lien on property/assets taken by a lender as security for the repayment of a senior loan. The term “mortgage” or “mortgage loan” are used loosely to refer both to the lien and the loan. In most cases, they are defined in two separate documents: a mortgage and a note or loan agreement.

SONIA: Sterling Overnight Interbank Average Rate, the “unsecured overnight rate for wholesale funds” and main reference used for international commercial loans and related transactions. First launched in 1997, it is an alternative benchmark interest rate for financial contracts since it does not incorporate any credit risk associated with the recently-tarnished LIBOR. More at definition.

Sources & Uses Statement:  A table that captures the presumed sources of funding and lists the various uses of that total funding by category and percentage of the total amount to be raised.  More via this 3-page PDF download, which also includes an example of a draw schedule, used for the Completion Assurance [Financial Guarantee] Program.

Sponsor or Backer for CAP funding:  see landing page to introduce potential sponsors to this innovative project financing.  1-page Overview for Guarantors

Standby Letter of Credit:  Similar to a Bank Guarantee, Standby Letters of Credit (SbLCs or SLOCs) are legal/financial instruments providing a financial guarantee of various types.  For funding purposes, an SBLC guarantees a bank’s commitment of payment to a Beneficiary if the bank’s client defaults on the agreement. SBLCs help facilitate international financing and (although not In3’s business) trade between companies that do not know each other and have different laws and regulations.

In other words, an SBLC assures a Beneficiary that the parties will act in accordance with their commercial obligations (responsible uses of funds, in the case of project finance, cooperation in resolving issues or disputes, or payments made in trade transactions, or nonfinancial obligations performed by a seller or provider). Standby Letters of Credit are essentially fail-safe devices: If the issuing team doesn’t fulfill the terms of their contract(s), the beneficiary can “activate” the SBLC, which then prompts the parties to resolve the breach.  In the case of fraud, failure, or default on said obligations (worst case scenario and the resource of last resort), it can provide compensation.  FAQ on this: “What reassurance is there that the guarantee, once sent, will not be misused, called or cashed in?”

SWIFT:  Society for Worldwide Interbank Financial Telecommunications allows financial institutions across the globe to send and receive financial messages in a standard and secure manner.

Next steps? 

If you are seeking funding, try our fast/easy readiness assessment (RAIN) was built with applied learning in mind, as no proposal is perfect (because we humans are not perfect), bolstering confidence in what you know to be strengths but also open-minded awareness (dare to be humble and slightly less wedded to having the “right idea”?) about what issues or improvement opportunities remain.

We look forward to hearing from you!