Milestone 5: Develop Business Case and Financial Model
You’ll have started building your business case and financial model in earlier steps – laying out your project’s vision, the market proposition and estimating costs and income. This step offers a review, in addition to providing details needed to build out the financial model and business case more fully. Both of these key documents will be iterated throughout project development, and will likely be altered during project delivery as new information emerges. These documents are interlinked and, if developed correctly, will ensure your project’s viability and help you with discussions with stakeholders – including sellers, buyers and future investors.
The financial model will also enable you to better understand the type of structure your project may take to attract investment (i.e.a loan, an equity investment, a bond) and what sort of returns you can afford to pay/offer.
This milestone contains three subsets of considerations or ‘themes’ that project developers may want to explore at this stage. Click on each of these themes to the right in order to read more.
You can also read case studies of projects that have successfully completed this milestone of development and view a summary of the common activities undertaken at this stage below.
Developing the financial model
Financial models in projects of this type are usually structured as in spreadsheet form. Building up a full picture of costs and income is necessary to then identify any need for investment and test the project’s financial robustness.
For simplicity, the types of costs that you might face over the lifetime of the delivery of your project can be split into three separate stages:
- Development costs – before the project gets to a point where it can generate any revenue or attract grants, development costs feed into the design and planning of the project itself.
- Implementation costs – once legal agreements have been signed and a trade or deal is officially confirmed, implementation costs are derived from the upfront costs of your project, such as habitat establishment.
- Post implementation costs – after the implementation costs are paid, there are a number of lifetime or ongoing costs that must be considered as part of the financial model.
Below is a table to demonstrate these costs in further detail.
Some questions to explore when assessing your costs include:
- What development costs have been incurred to date? What development costs remain?
- How am I valuing my own time spent in the project’s development and the time that I will give once it is fully operational?
- What are my future costs? When is the earliest that these will need to be paid?
- Am I considering all types of costs across my project’s lifetime?
- How will the costs of the project be recognised in the project’s accounts (i.e. in relation to income recognised)
- How am I factoring in any income foregone – e.g. for the landowner?
- How am I accounting for inflation over the lifetime of the project’s costs?
Below is a diagram that depicts how income for a nature market deal typically comes from:
- Income from buyers – payments from the beneficiaries for the measurable, robust delivery of the ecosystem service. This can include payments for BNG units, carbon units, or potentially rental payments (where a buyer or third party leases the land to produce ecosystem services). Sometimes buyers are willing to make payments early to meet certain development costs.
- Environmental grants – usually provided by government and philanthropic sources to support environmental outcomes, such as the Environmental Land Management schemes. This can also include Corporate Social Responsibility (CSR) funding from businesses.
- Development grants – like with environmental grants, some government and philanthropic sources offer funds to specifically cover development costs, including the projects supported by the NEIRF and FIRNS.
Note: for simplicity, this Toolkit does not consider the use of internal funds, funds of a third-party project developer, or an investor (see Milestone 7) as income, due to the fact that these must all be repaid in some capacity. These can however be considered as potential sources of funding.
Some useful questions to explore when assessing your income / funding streams include:
- What is the income conditional on from the buyers’ / funders’ perspective?
- Can the project receive advanced payment from the buyer(s) to meet certain costs?
- What is the ability for the project to bundle or stack payments for different ecosystem services?
- What is the regulatory risk to each source of income?
- What tax treatment will each source of income receive?
- What are the timings of the payments, and how will that affect the project’s cashflow / general accounting?
- How can I factor inflation into any future payments from buyers?
All financial models rely on assumptions that essentially serve as inputs to the model (unless these inputs have been contractually agreed). These include direct assumptions about the financial figures – such as the inflation rate or the price the ecosystem service will achieve, and indirect assumptions on the progression of the project – such as the expected date that necessary permits are issued or the completion date of any habitat creation work.
All identifiable assumptions should be listed within the financial model – usually on a separate spreadsheet – to create a view of the factors beyond the project’s complete control.
As you build a view of these assumptions, you can ‘stress test‘ your cashflow to see how financially stable it is and how your expected profit or cash reserves might change. This is sometimes called sensitivity analysis, or scenario modelling.
For example, you might ask yourself: What if:
- the initial works on the habitat are delayed by a year?
- the market price falls when I plan to sell?
- a certain environmental grant is not secured?
- the habitat fails in Year Five?
- the inflation rate goes up?
From both a core project perspective and the perspective of the individual stakeholders involved, it is important to know how these scenarios will translate to a financial risk. As a result, you might consider:
- building in a cost contingency as a percentage of all your costs
- taking out insurance or an indemnity
- building in a cash buffer, or reserving extra land for the deal (a land buffer)
- using upfront investment – such as debt or equity – to close any shortfalls in cashflow (see Milestone 7).
The above considerations – building an accurate picture of costs, income, and assessing key assumptions – represent the bulk of work when it comes to building the financial model of your project. However, below are some additional questions that may be useful to ask around the general management of the financial model.
- What is the anticipated timeline of my project?
The model should span the complete lifetime of the project, up to when no costs, incomes or investment payments are being transacted and the site is no longer contractually required to be kept in its target state. For some projects, this could be 100 years or more. Some project developers may also wish to extend the financial model to beyond the project’s contractual obligations – aiming to keep habitats in perpetuity.
Timescales across your forecast can vary to represent the frequency of these monetary flows, for example the model could start with monthly periods to represent the remaining project development costs, weekly periods when habitat restoration or construction work begins, and then yearly periods when the site is under maintenance and monitoring.
- Will I need a financial advisor?
You may choose to engage with a financial advisor that has experience in building financial models for nature-based projects and other relevant commercial experience. Examples of such advisors are included in the case studies of this Milestone. Alternatively, you may also consider:
- Asking your existing service providers for recommendations, such as your lawyer, land agent, partner ecologist, or accountant.
- Browsing the the CLA’s Natural Capital Business Directory (England only).
- How often is financial data being collected and reviewed?
As the project progresses, new financial data will become available that should be included in the model, such as realised costs of restoration or updated quotes relating to service agreements. Management accounts should be maintained by an accounting professional with quarterly variance (actual vs budget) analysis reported to the project’s board or steering group – tying in with your project’s governance structure (see Milestone 6).
- What systems are being used to store financial records and help with accounting?
Consider where you are storing the project’s financial model and who may need access to it, such as senior decision makers or financial advisors. This could be a simple Excel file kept on a SharePoint site, or a more formal software package that is designed to streamline invoice and accounting information.
Identifying the need for investment and testing the financial model
As you build a more complete picture of the financial model, you can identify if there is a need for upfront investment. Testing – such as sensitivity analysis (see below) – will also demonstrate the financial viability of the project and show where it is vulnerable to certain risks and assumptions. You can use this information to improve the project’s resiliency, potentially with the use of up-front investment.
After mapping all costs and incomes, you will be able to see the project’s free cash flow – how much cash the project has to hand at the end of each period. Here you will see where there is a predicted surplus or lack of cash under your assumptions.
Because the cash flow represents the project’s cash balance at any given point, it’s important that all transaction dates are accurate and represent when money is actually flowing in or out of the project, in line with payment terms.
Based on your financial model and any sensitivity analysis undertaken, you will have a clearer picture of where the project is financially resilient and at what point(s) the project falls short of cash. This will demonstrate where there is a need for up-front investment. More detail on this ‘investment ask’ can be found in Milestone 7.
Upfront investment could be provided by stakeholders already engaged in the project, for example if the buyer is comfortable with paying for the ecosystem services in advance, or if the landowner wishes to cover any short-term cash shortfalls with their own funds.
However, you may consider bringing in a third-party investor, in which case you will need to determine what is the project’s ability to repay this up-front investment and what extra financial return you can offer the investor. This will be determined directly by the project’s free cash flow over its lifetime, and the investors’ return requirement, as determined by the level of risk within the project.
Building on the above question, you may consider different metrics that demonstrate the return that your project can provide investors, and include these in your testing (see below).
A commonly used metric is the Internal Rate of Return (IRR) that gives an annualised rate of return, known as the ‘discount rate’. Investors often use this metric as it gives a figure to compare to their own investment needs, but the simpler Return on Investment (ROI) across the lifetime of the project is also sometimes calculated. A useful comparison of these two metrics can be found here.
If you have a target rate of return in mind for an investor group, it is possible to ‘back solve’ your financial model by setting the target rate of return in your spreadsheet, using a certain formula, that will then indicate where there is a shortfall in free cash flow. You can then use this information to adjust or iterate your financial modelling, such as the renegotiation of payment schedules with buyers.
All financial models rely on assumptions that essentially serve as inputs to the model (unless these inputs have been contractually agreed). These include direct assumptions about the financial figures – such as the inflation rate or the price the ecosystem service will achieve, and indirect assumptions on the progression of the project – such as the expected date that necessary permits are issued or the completion date of any habitat creation work.
All identifiable assumptions should be listed within the financial model – usually on a separate spreadsheet – to create a view of the factors beyond the project’s complete control.
In the context of financial modelling, a sensitivity analysis is where the assumptions of a model are altered to determine how the project will be affected by unexpected changes. This is sometimes called scenario modelling.
Investors and other external stakeholders will want to see a sensitivity analysis as it will demonstrate the project’s resilience. For example, what will happen to the project’s cash position if the costs to implement the interventions on the site rise by 10%, or if some of these interventions fail after a year? How will the sale of any carbon credits agreed through an offtake agreement be affected if the required third-party validation of the site’s new condition is delayed by six months?
To present your sensitivity analysis in a more formal way, consider picking ‘target output’ figures that represent the health of the project, such as the internal rate of return and the free cash flow, and then identify what inputs and assumptions the project is most influenced by when changed, such as the costs of initial interventions or the unit price of ecosystem services. You can then create copies of your initial financial model – known as the ‘base case’ – and change these key assumptions across each copy to represent different scenarios.
You can then create a summary table to show how the inputs have been changed across each scenario and what effect these have had on the target outputs. This is the most common way of presenting the findings of your sensitivity analysis or scenario modelling to external stakeholders.
Some projects decide to set aside a cash buffer or reserve, sometimes called a minimum cash position, by looking at its upcoming financial obligations and subtracting the amount needed from the free cash flow.
To assess how far in advance you should look in terms of these upcoming financial obligations, consider how often income is coming into the project and how consistently. If income flows are more sporadic, you will need to cover longer periods with your cash reserve.
Writing the business case
The business case (sometimes referred to as a business plan) is a sizeable written document that captures the reasoning for why and how the project is being delivered, and also its commercial viability, driven by outputs of the financial model. Key stakeholders – such as buyers and investors – will likely want to see a draft or finalised business case. Some stakeholders may even want to be actively involved in its creation to ensure that the plans align with their own needs and asks.
There are several ways you can set out a business case, with some recommended tools included in this section. For whatever structure you choose, below are some questions to help identify useful content. These are ordered in a way that is typically seen in commercial settings.
- Can I summarise the project in a single page or less?
A basic overview of the project should be given up front for context. This is typically a single page or less and should include the opportunity of the project to deliver both environmental and financial gains – acting as a ‘teaser’ introduction for the entire document.
- What is the ‘Ask’ of the audience?
You may have a general business case on file with no audience member in mind, but if you’re sending this to external stakeholders who want a full view of the project, you should state the ask of this audience clearly and early on. This could be for a new landowner to join your existing seller group, a buyer to pay for part of the project, or an investor to cover up-front capital costs. High level terms should be included and built on later in the business case.
- What is the ecosystem service that the project is delivering? Why is it being delivered through this project particularly?
Your audience may have a more developed understanding of the topic of ecosystem services and how they are increasingly being valued. However, it’s advised that in the written business case you assume minimal knowledge on this and explain what ecosystem services are being generated from the project and how, including any environmental drivers and key delivery partners you are working with.
- What is the wider market that this project sits in, and why has the project been started with private finance?
Alongside the above ecological explanation, you should outline the current market for this service, what transactions have taken place to date, economic drivers, regulatory drivers and any other information that supports why private finance is being used in this project rather than relying on just public or philanthropic support.
- What is the project’s ‘Theory of Change’ in delivering environmental and social outcomes?
A Theory of Change is a document that is commonly used in philanthropic and commercial settings when discussing the delivery of long term impact, such as environmental or social gains. Most investors will be familiar with this structure, and it can help you to demonstrate how the project will deliver lasting change that spans beyond the timeline of their investment, which will be crucial.
- Can I show that the project fits into a wider vision for nature restoration in a landscape?
Project stakeholders, including investors and buyers, will generally value efforts of a project to align to the wider strategy in a landscape, as it can show a capacity for collaboration, synergies and deduplication of effort, and deliberate thinking as to how the project can deliver holistic environmental outcomes. You may want to stress in further detail here any key delivery partners, such as eNGOs, who you’ve worked with to date.
- What are the short and long-term targets of the project?
A good business case will include defined short-term and long-term targets that show how the overall goals of the project will be delivered. Depending on the type and lifespan of the project, the split between short-term and long-term may be different.
For example, short term targets might simply be the completion of habitat restoration/creation work within a year. You can also include targets for remaining project development, such as remaining contract negotiation with buyers. Longer term targets might include environmental gain, effective maintenance of the habitat, sustained community engagement, and the replication of the project elsewhere as a sign of shared learning. These can be qualitative targets that are underpinned by key performance indicators (see below).
- What are the indicators for progress on these?
You can make many qualitative statements about the goals of the project, though often they will be more easily valued by external stakeholders if they can be measured. Key Performance Indicators (KPIs) are a commonly used commercial term that involve the quantification of progress or performance within a timeframe.
For example, you will include the metric of performance for your ecosystem service(s), such as tonnage of CO2e sequestered for a new woodland, but you could also include measurements for community engagement, such as number of estimated visitors per year, if that woodland has public access built in.
To set out the KPIs, it may be useful to take the financial model spreadsheet of the project and create a second section underneath to show how you expect KPIs to perform under the same timeframe. Investors and buyers generally value this approach as it shows how financial flows translate to outcomes of the project.
- What is the unique advantage that the project has in achieving these?
To demonstrate strategic thinking around the project, you can include the advantages that you plan to leverage that makes the project unique and/or likely to succeed. This could involve the collaboration with farming clusters to make the project scalable, a new methodology being used to assess the delivery of ecosystem services, transactional agreement structures, backing from regulatory bodies, or particular features of the site(s).
Ultimately, this question brings out why your project is different and therefore why it should be supported over other choices that the audience might have in terms of the time and resources they are expected to commit to the project.
- What is the overall profitability of the project? What returns are being offered?
At a high level, the business case should speak to the profitability of the project. This is usually defined as the free cashflow and internal rate of return (IRR) of the project. If presenting to investors that are being offered a return, you should also include details on what returns they are being offered, when, and how these have been included in the financial model.
- What is the volume and unit of the ecosystem service? How is this being priced?
For example, if your carbon sequestration is being unitised as tonnes of CO2e per year, if your sustainably produced timber is sold as whole trees or cut into standardised logs, or if your ecotourism product is charged via a day rate or a multi-day package deal per visitor. You should give detail here on how much volume of your sellable ecosystem service you are expecting to generate, and how the price is being set.
- What is the transaction structure?
For example, BNG units being paid for via a Unit Purchase Agreement with a single upfront payment, an offtake agreement being used to sell the carbon units over a period of time, or a fixed payments contract being used to pay for flood risk reduction. You should include detail here on the expected timings of these payments and what they are conditional on.
- How is price expected to change? What is the selling strategy?
If relevant, you can include here how the price for your ecosystem service(s) is expected to fluctuate and how you plan to mitigate this market risk through your selling strategy or use an expected increase in price to serve the financial viability of the project.
- Are there any government revenue guarantees or schemes that minimise market risk?
You may have some form of guarantee from the government or another entity that helps to minimise the market risk, which is useful to include in your business plan with detail on how this works for the audience. The Woodland Carbon Guarantee is an example of this.
- What kind of investment is being sought to enable this?
If you are presenting your business case to a potential investor, you will also want to outline what investment you are seeking and in what form, for instance an equity shares or a long-term loan with collateral, and what costs the investment will be used to cover. This section should align to the overall set of information you use to approach investors (See Milestone 7).
- What is the management team of the project? What experience do members have?
A short biography should be included of the individuals involved in the project’s development, and also who will be leading its implementation once the project is operational, if these differ. These bios – typically one to two paragraphs – should include their training, organisational successes and important accomplishments in the field.
- What is the organisational structure of the project?
Consider setting out the desired organisational structure, how many people the project wants to employ or engage and how everyone will communicate to ensure everything goes as planned. This section outlines the logistics of who does what and when. The key partners and service providers of the project should be highlighted here, and what they are delivering. This content should align to the outputs from Milestone 6.
- How has internal and external capacity been assessed? What skills / experiences are key?
This is an important question to ensure all the capacity needed to deliver the project’s goals across its lifetime has been captured in planning.
You may consider doing a skills gap analysis to prove this thinking has been taken into account. Instead of starting with the individuals, consider starting with the goals and targets of the project over its lifetime, then identify the activities needed for these goals, then the skills and experiences and finally the individuals who are best suited for this work.
For example, if the project plans to scale its model by forming partnerships across different catchments, when and how does the project plan to do this? What experience and skills are needed for this work? Is this capacity already established in the team, and how were these individuals selected? If not, how does the project plan to recruit new team members when this capacity is needed?
- What are the project’s dependencies and risks, and how are these being managed / mitigated?
A project will have several dependencies and resulting risks, such as the dependency on accreditation via a certain code to sell credits, and the risk of not achieving this accreditation on the project’s targets. Project developers should have an overview of the
This is also essential for investors to understand the project and assess their own return requirements (See Milestone 7).
- Should I include a risk register?
To present this information in a clear and concise way, consider using a risk register (also known as a risk management matrix). A risk register includes the risks of the project and addressing actions, but also the likeliness of each risk materialising and the impact it would have on the project. External stakeholders, such as investors, often use the ‘likelihood x impact = severity’ equation of each risk across the project to build a picture of the overall risk profile.
Building on from the example given in the previous consideration, a project may seek accreditation to sell environmental credits to a buyer, with a contracted offtake agreement that is dependent on accreditation being achieved by a certain date. If accreditation is not achieved then the impact on the project’s delivery would be high, but the likelihood of this could be substantially lowered if the project team has been frequently engaging with the accrediting body before its assessment of the project. Therefore, the profile of this risk is relatively low.
- Do I have a suitable marketing and communications strategy in place?
Your business case should include considerations on your marketing and communications strategy towards all external stakeholders, such as potential buyers, investors, community members, eNGOs and government entities.
Depending on the size and complexity of the project, these strategies will have different levels of depth and formality. However, it’s important to reflect on the question of ‘how do I want the project to be perceived externally, and by who?’ as this perception may be a critical factor in the success of your project. Including the strategy (or a high-level summary) in your business case will show the viewer that you understand this.
- How do I develop a marketing and communications strategy?
There are several ways to develop your communications strategy, and if you are not sure then the partners you’ve engaged to date, such as eNGOs or commercial advisors, may have a defined structure for the project to follow.
The strategy should include the main objectives of your communication work, e.g., communicating the replicability of your project’s blueprint to other parts of the UK, or gaining investor interest, and the ‘core messaging’ of the project that can be relied on as a ‘baseline’ truth for any communications event.
As a starting point, consider undertaking a full stakeholder mapping exercise, using the power-interest matrix that breaks down your stakeholders into groups of those with high/low interest and high/low power over the project. You can then use this map to think about the specific messaging you’d like each of these groups to receive about your projects, actions and initiatives that will effectively convey this messaging, and then those responsible for executing this work.
