The financial models we use are living, breathing representations of some current state. Some are used for short term analysis while others live for many years. As such, we need to factor in how a model can change over times as its uses transform.
Let’s consider renewable energy project models, a key use case in our business. The following describes how a model may evolve throught a non-exhaustive list of stages.
Development Stage. A project generally starts as an idea where a facility might be located on some land. There is very little know about the project at this point, but assumptions must be made to determine viability. In particular, cost of land, cost to build a project, potential revenue streams, operating expenses, tax benefits/costs, and useful life. This will generally be enough information to determine an IRR.
NTP Transaction Stage. Prior to being able to start construction, the development assets associated with a project may be sold. This requires both the buyer and the seller to update the above modeling assumptions wtih their respective views and to tussle over valuation based on the most defensible position. The parties may also udate the model for more detailed financing assumptions; in the seller’s case to justify valuation, and in the buyer’s case to confirm the project economic hurdles can be reached once fully structured. In terms of whose model will be used, the seller will continue to use their model, while the buyer (a) may be given the seller’s model to update or (b) use their own model using a mix of seller and buyer internal assumptions.
Preliminary Financing Stage. When the party that will own the project is ready to go out for financing, there will be another model refresh to reflect the latest projet informaiton as well as the latest financial strucuturing and market terms. Additional specificity may be added here to sharpen the structure. For example, construction debt may be ommitted in prior versions but should be included since it will be required to advance the project(s).
Transaction Stage Modeling. Once financing terms are received, the model will need another refresh and likely additional sections will be added to the model to match the specific terms. Ofter lenders and equity investors will have different terms based on their preferred structures. This can represent a material change in the model as such structure changes can be complex and require changes in both the project and structuring sections of the model.
Draw Model. As the project is built, the transaction model needs to be continually updated to assist with construction loan and any equity draws.
Financial Close Model. As final draws and made and construction debt converts to term debt, closing models are established that are synchronized with the transaction documents and become a demarcation point for project and financing monitoring.
Tracking Model. After financial close, and sometimes for periods of 30+ years, each project’s economics need to be tracked for purposes of complying with the financing agreements, but also to transfer data into the owner’s accounting system and for general asset management.
Even this simplified account represents a lot of touch points for model changes over time. This is mostly done in Excel and new parties take over the models and try to decipher what other model owners intended in the past. There are almost always errors, which when discovered need to be patched, often times leading to renegotiations with counterparties.
Hopefully it is clear why a database application, like Structrz, would be useful for layering in model changes over time. Using our modular approach to model building outlined in previous posts, it is almost surprising that there is no best practice around model evolution for a single asset. Even if just using Excel, employing out Schedule Based Modeling (SBM) techniquest can reduce errors and improve throughput of models over time.