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Financial Instrument Framework Spectrum

April 10, 2019 by in Models
This Financial Instrument Framework from the Missing Middles Report by the Collaborative for Frontier Finance (Omidyar Network / Dutch Good Growth Fund [DGGF]) offers an excellent snapshot for mapping the spectrum of investment instruments in terms of risk and return expectations.

Debt:

  • Asset-based lending: any form of lending that is secured by a non-current asset
  • Leasing / pay-as-you-go: an agreement whereby the owner of the asset (lessor) provides a customer (lessee) with the right to use the asset for a specified period of time in exchange for a series of payments
  • Trade financing: a short-term instrument involving a lender, buyer, and seller that is issued in financing trade flows between a buyer, who wants to ensure he or she is buying the correct good, and a seller, who wants to make sure he or she is paid as per the agreement
  • Cash-flow-based lending: a loan that is backed by the recipient’s business cash flows (e.g., factoring, warehouse receipts, purchase order finance)
  • Working capital: a credit facility made available to a borrower that can be tapped at the borrower’s discretion and according to set rules governing the facility (e.g., overdraft protection, demand loans, and revolving credit lines)

Mezzanine:

  • Partially unsecured / junior loan: a loan with tailored repayment structure and flexibility regarding collateralization requirements
  • Royalty-based lending: a loan that provides the investor with a base interest plus royalties, which are payments that depend on the performance of the company—usually a percentage of revenue of EBIT(DA)
  • Convertible loan: typically a loan with a maturity date and a regular payment schedule, as well as an option to convert the loan into shares
  • Preference shares: shares that are given preference over ordinary shares, including priority in receipt of dividend and upon liquidation, often with a fixed annual dividend
  • Redeemable equity: largely similar to ordinary shares, but with a right to sell the shares back to the entrepreneur (put option), typically using a predetermined price or a formula

Equity:

  • Common shares: shares of common stock provide an ownership interest in the company, along with voting rights and possible dividends; dividends are not guarantees and may be suspended if the company struggles financially; holders of common stock are the last to be paid if the company liquidates

Grants:

  • Convertible grant: a grant that is provided to an investee that can be converted into debt or equity based upon success
  • Unrestricted vs. restricted grant / TA: the distinction between a grant that can be used for general use free from external restrictions (unrestricted) and one that comes with stipulations or requirements (restricted)
  • Refundable vs. non-refundable grant / TA: the distinction between a grant that can be paid back to the original provider of the grant (refundable) and one that cannot be paid back (non-refundable)

Commercial risk mitigation instruments:

  • Insurance: a contract, represented by a policy, in which an entity receives financial protection or reimbursement from
    an insurance company against losses (e.g., weather, political risk, etc.)
  • Guarantee: a non-cancellable indemnity bond backed by an insurer to guarantee investors that principal and interest payments will be made
  • Currency hedging: a contract that protects against unexpected, expected, or anticipated changes in currency exchange rates

Blended finance instruments:

  • Concessional loan: a loan that is provided on more favorable terms than the borrower could obtain in the marketplace
  • Development impact bond: an outcome-based contract whereby private investors provide upfront funding for social development interventions and are remunerated by public sector agencies at a commercial rate of return if evidence shows that the intended outcomes were achieved
  • Risk-sharing facility: a loss-sharing agreement between an entity (typically a multilateral development bank) and an originator of assets in which the multilateral development bank reimburses the originator for a portion of the principal losses incurred on a portfolio of eligible assets

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