Here is how it would all work:
When a US small business embarks on a project, it typically borrows most of the cash needed on the strength of its credit rating and the collateral that may be afforded by the project and its potential future value upon completion. A good example is a real estate development project.
Quite often the size of a project may be much greater than can be justified by the strength of the business' current balance sheet. In other words, the investor needs leverage. One way to obtain that leverage, is to obtain a direct pay letter of credit (LOC) from a bank. The bank does not necessarily make the loan, but they evaluate the project and agree to "stand behind" the investor for a portion of the financing.
The investor then takes the LOC to the capital markets and secures financing via an investment banker (or market maker) who brings the investor together with a lender.
For a well vetted project, everyone involved makes a fair and reasonable profit.
In the case of attracting millions of US investment dollars into Cape Verde, the goal would be to focus on tourism projects. These are a natural because the tourism sector is experiencing very strong growth and is able to generate the returns needed on investments to make such ventures attractive to potential investors. In addition, the Cape Verde government provides very attractive tax and investment incentives to make such investments in Cape Verde.
Here's is what would happen under a creatively financed project:
- The US investor would propose a well thought out project in the tourism sector. This would be vetted by the government which also has a vested interest in seeing the project become a reality. As noted in an earlier post, the government would need to clear the unacceptable red tape and time delays out of the way of the project. This is not to say that any laws should be waived. Instead, it is simply to point out that something that should take a week should not end up taking a month, and the government should ensure that various steps are completed as quickly as possible once the investor has done his or her part at each stage of the process.
- Once the project is vetted, the government would issue a LOC on the basis of the strength of the project, its value to Cape Verde's economy and the investor's track record in bringing such projects to fruition. The government issue no loans! But the government could charge a fee for the amount covered by the LOC. The typical fee for a letter of credit is about 60 bps, but could be higher or lower depending on the riskiness of the project.
- The investor takes the LOC to an investment bank in the US. The LOC effectively says that the full faith and credit of the Cape Verde government stands behind the actual financing that will be provided by a willing US lender.
- The US lender would be a money market fund. Money market funds typically pay money market holders a rate that is close to LIBOR. But they have to cover their investment management fees which are very low for a money market fund. Thus the money market is willing to lend large amounts of cash for 7-30 days (that is the definition of a cash investment in the US). They would lend these amounts at a cost of LIBOR + 60-70 bps. The loan would renew every 7-30 days so that it is a floating rate cash investment from the perspective of the fund. The loan would be amortized over 25-40 years. The reason that money markets could lend for such a long period is that money market funds do not see rapid velocity or movement of funds. The funds are extremely stable so there is no need to have 100% of the fund available in actual cash. Keep in mind that there are trillions of dollars currently in US money market funds and they are always looking for credit-worthy borrowers for large loans.
- The investor is thus provided with the desired amount of financing at a very low cost of funds (LIBOR + 150 bps all in) to place into the project and is rewarded with the net cash flows from the project. Once the project is completed and cash flows begin to turn on a consistent basis, the investor pays off the loan or seeks traditional financing which is then easier to obtain. The LOC from the Cape Verde government is then terminated.
Everyone wins. The Cape Verde government receives real revenue for issuing the LOC. The money market fund earns the revenues needed to pay its shareholders and cover its expenses and profits. The investment bank makes its commission (typically 1-2%). The investor obtains the financing needed to complete the project. And Cape Verde wins because it benefits from the completion of another tourism project which creates more jobs and contributes more tourism revenues to GDP.