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Here is the recording. It was a great session.
Since we started running the Solar Executive MBA course (click here if you want to learn more about the Solar MBA) and teaching experienced solar professionals what they needed to know to finance commercial solar projects, we continuously get a large volume of questions specifically about financing non-profit solar projects.
Here are the Five Questions that we Answered
I’m in the process of completing my first PPA. Our company is no longer structured to take advantage of tax credits for PPA’s, thus I am struggling to find investors to take a project. What is the best way to find investors? What is their profile? How should I approach them? How long does it typically take from the first time I speak with them to closing a deal?
The best way to find investors- perhaps the question is, what part of the investment is needed? Debt? Equity? Each part is different and often one party could bring one to the table and not the other. It also depends on the size of the deal. Small deals are often not as attractive to institutional investors.
If it is a small project, there’s an opportunity to get a loan via the local bank and finding tax equity investors is usually more challenging. The amount of time to closing can vary greatly, depending upon the deals characteristics and competing deals with higher returns and lower risks.
Approaching investors can come in a variety of ways. If it is a PPA on a for profit business, this can usually be easier to find. Offtakers for a for profit business are going to look at all the documents related to the project and who the company is. Often 3 years of audited financials of the company/host is going to be required in order to qualify the project from an investor’s perspective. There will also need to be title search done on the property to make sure there are no encumbrances. Also looking at the type of business that it is and its long-term goals is critical, as PPA’s go out 15-20 years in the future. Will they be around? Can the PPA be assigned to the new owner? Is the property in a desirable location and can it be sub-leased?
If we are looking at a small project on a non-profit, like a house of worship, there could be affinity investors (high net worth), or people that go there, that could become the investors. They could be accredited investors and be able to hurdle the SEC and financing rules to be a good fit for your project. If they have other investment vehicles, like real estate, then their profiles could match the profile of an energy project. Providing them with a summary of the project, a pro-forma and other related supporting documents can assist you in the marketing of the project.
If it is a larger project, where you need institutional investors, contacting your local lending institutions to see who is doing deals, as they usually know what is happening at loan origination or in their leasing departments (which are usually now called Equipment Financing). They will have access to contacts and it is those relationships that you want to foster.
The amount of time that it can take can vary. We’ve seen spans of 8-12 weeks or more, depending upon the circumstances.
Does the recent push for, and acceptance of, crowdfunding in solar provide opportunities in financing not for profit solar projects? If so, how?
Yes, but before we get to how, let’s talk about what crowd funding is and how it differs from traditional financing. Traditional project financing involves raising capital – debt and/or equity. Both the Federal government (primarily through the SEC and banking rules) and each State (through “Blue Sky” and state banking requirements) regulate the when, how and from whom of raising capital. The regulations were created in the wake of the prevalent fraud and abuse that characterized the 1920’s capital markets right before the great market crash of 1929. As a consequence of these rules, sophisticate financial institutions generally provide the bulk of all project financing in the U.S.
With the advent of the Internet age, Congress has begun loosening the rules that regulate raising capital, and one result is the emergence of crowd funding. Crowd funding uses the Internet to raise small amounts of money for a specific project from a lot of different people. For the moment it is primarily limited to debt – equity is still on the horizon, but coming soon. (Even when it does come, it will probably be limited to very small transactions, for example under $1 million, and not likely to be well suited to provide tax equity.) But even so, low cost debt – well under 10% and probably average between 6 and 7 percent in today’s market – can still greatly enable a project.
The leading crowd funding platform for solar projects is probably Solar Mosaic. Here is how Solar Mosaic works. Solar Mosaic performs due diligence on the project and if the project meets its threshold requirements will enter a funding agreement pursuant to which Solar Mosaic lends the project $X, at an agreed upon rate and term. Solar Mosaic then raises money by posting the project investment opportunity on its web site. Effectively Solar Mosaic is issuing its own non-recourse notes (secured solely by the revenue from the Project company’s note). Prospective investors have access to the due diligence material. Each investor that likes the Project, including the return, can sign up for an amount of its choosing (subject to a max and min). Once the full amount has been raised, the transaction is closed to further investors.
Crowd Sourcing can work particularly well for non-profits because it allows “affinity investors” an opportunity to participate in a carefully structured transaction and benefit from the due diligence and data gathering presented by Solar Mosaic. An Affinity Investor is someone otherwise affiliated with, or supportive of, the non-profit’s mission. For example, an Affinity Investor for a Church might be a member of the congregation.
Crowd Sourcing is particularly useful for affinity investors because it offers smaller investors an opportunity to participate, and – because it involves only debt and no tax equity – doesn’t require investors with substantial “tax appetite”.
The negative of Crowd Sourcing for non-profits, is that a tax equity investor must still be found. In fact, if a project is not viable without tax equity, then Crowd Sourcing can only reduce – but never eliminate – the need for tax equity.
I’m specifically interested in issues associated with members of a non-profit organization providing the tax equity financing for a solar installation on their own church, temple, or faith community. How can this be done? What are the issues that need to be addressed with passive income and securities regulation for the investors in these third-party systems on non-profits?
As in our first question, identifying people that fit the profile is essential. Knowing what the characteristics are early and focusing on who your ideal candidate is will eliminate a lot of potential people that are interested, but don’t qualify. Like question #1, the issue always at hand is the passive income rules. This is something you need to talk to your accountant and attorney about. These deals are done often, but it requires more scrutiny from the investor’s perspective, as sometimes, non-profits don’t have a long track record and could also cease business operations as well. As an example, even in a house of worship, a leader in the organization, like a pastor, could leave and take his flock with him to another location, emptying the church and its operations. This will adversely impact an investor and is a risk you should consider.
Active income, is income received like a salary from your company or a gain from the sale of an asset or a business. Passive income, is from things like a rental income. If you receive losses from a business but aren’t an active participant in the business, this is considered passive income.
The challenge is most individuals don’t earn much passive income and has been the issue for a long time, as it relates to investors capacities with solar assets. The other issue is that passive investors can only use tax credits or depreciation to offset other forms of passive income.
What should be on a due diligence checklist for screening non-profits clients and potential investors for those projects?
Due diligence can be lengthy and can also be brief. We like to get as many details about a project, but often in local markets, many vetting cycles for smaller projects are relationship based. (at least that is the case here).
It is also desirable to setup an online data room to effectively manage the layers of documents and correspondence during this process. This keeps everyone informed and up to date with the latest revisions of the documents and limits the digging into your email for the most relevant doc sets.
Developing a detailed process for gathering this information is essential as having a framework will assist you and your team in a consistent way for finding projects as well as how investors will look at working with you. Investors often know others that are in the market for these types of opportunities and creating a template of the items you and they need to go through streamlines the process.
Here is a brief list of items you should consider in vetting a project. Note they are in categories and are essential in streamlining the process of lead generation to COD.
- Site Control- this by far is the most important first step in the process. Having a LOI with a building or landowner is the first step. Once this is secured, you can do your feasibility study to determine the system size and other environmental attributes associated to the preliminary permitting scope to provide the land owner with a MOU and lease document. These are usually contingent upon the findings of the next step.
- Permitting- this is one that will make or break the economics of a deal. You could have an unforeseen site condition that could halt the development of your project or an added cost that will make the return the investor needs to fund the project, undesirable.
- Power offtake- who is buying your power? Rooftop and it’s the customer and the utility or is it a PPA directly with the utility? Knowing these things early determines the economic desirability for an investors appetite and risk.
- Project finance-what kind of funding sources are you looking for? What will be the terms of the deal for investors? Is is a direct purchase, sale-leaseback, partnership flip? Who will monetize the incentives? Are there insurance policies to manage risk? Is there a clear construction schedule and penalties for delay? Have you spoken to the utility for a schedule?
- Interconnection- where is the transmission line? Is it rooftop project and interconnection is easy? Do you know these costs and have a contingency fund if there are cost overruns? Do you have consulting engineers costs figured out? Are there any studies that need to be performed by the utilities that could take time and be an added cost?
- Engineering- what are your critical path items? Will you do everything in house or outsource? Do you have sub contractors that have done the work before that work with and understand the engineering requirements? Who will fill out the interconnection agreement? What will happen if the utility needs to curtail the system? Who will do the testing and verification?
With all due diligence, comes the risk of timing. As with solar tax credits, the end of the year timing is crucial in investor and tax planning. Not having your project built in the particular year you pitched to investors can have an adverse affect on their projected returns and can make the deal un-financable.
When would we want to use a PPA and when would we want to use a lease to finance a non-profit solar project.
The selection of a PPA vs. a Lease will be driven by at least two important factors. The first and most important is whether applicable law and the serving utility for the project permit a third party PPA. Under a PPA, the project owner sells power to a host customer. This sounds suspiciously like a utility’s job: selling and delivering power to a customer. Utility’s are heavily regulated entities, and – like all monopolies – jealously guard their turf. So as a general rule, PPA’s are not permitted unless expressly permitted by applicable state law or otherwise approved and acceptable to a utility. That is the bad news. The good news is that most state’s permit third party PPA’s where the power is produced and used on site, but they do so under different schemes. For example, in California PPA’s are permitted in all investor owned utility jurisdictions. Most municipal utilities either don’t permit PPA’s or limit how power may be produced and sold within their service territory. For example, LADPW has long interpreted its charter as preventing any other party from selling and delivering power to a retail customer within its service territory. Luckily, where PPA’s are not permitted, leases can and often do work. Under a lease, a user of electricity leases a solar system from a leasing company. The user then uses the solar system to generate and deliver for its own use solar power. (In both cases – a PPA and a lease – you must still follow all of the interconnection requirements.)
The second factor in determining whether to use a PPA or lease depends on the economic objectives of the non-profit, and the investors/project company. Under a PPA, a customer has little responsibility for a solar system other than to pay for the electricity delivered from it. The operating and maintenance expenses, taxes and insurance are all the responsibility of the power provider (and ultimately the investor). In addition, a PPA revenue stream looks variable because it will fluctuate with the number of kWh’s delivered by the system. That variability is important because if a solar system under delivers, or unexpectedly breaks, the risk and cost are all on the project company/investor.
By contrast, a lease shifts many of those risks to the non-profit. That is, under a lease, the payments due from the non-profit are fixed lease payments, and not variable PPA revenues. Put another way, under a lease the non-profit will be responsible for operations, maintenance, taxes and insurance. If the systems under performs or even fails to perform, the non-profit must continue to make the lease payments while bearing the cost of repairing the system.
In some cases, one might structure a lease to shift O&M, taxes and insurance back to the leasing company, but this will be a rare exception. Leasing companies are financing machines, and they don’t want any expenses. They prefer triple net type of leases, and a fixed stream of revenue.
Why are non-profits a special case? Why are we hosting this Q+A on financing solar on non-profits?
We organized a Q+A on commercial solar projects in August and it was a huge success. Click here to see the 60 minutes of video answering 7 questions ranging from how to calculate pre-tax vs post-tax ROI to what owner/lessor arrangements needed to be made in tenant situations.
Since then, we’ve had a large cohort ot students go through our Solar Executive MBA course (the next Solar MBA starts in February. In the class students learned how to finance commercial solar projects from start to finish, click here to test drive the Solar MBA course for free). Also, our Linkedin group on “best practices for financing commercial solar projects between 250kW and 3MW” has continued to grow.
What’s the one topic that we continue to get a lot of questions about?
You guessed it, how to finance non-profits. So, this is your chance to get your question answered.
There are several reasons why there has been such focus on non-profit clients.
- Non-profits operate on small budgets and they always need cash. Having lower and predictable operating expenses is very valuable to these organizations. It’s an easy sell to get your foot in the door.
- Non-profits have a social mission that tends to fit well with solar.
- There’s A LOT of non-profits! So the potential target market is huge. According to NCCS, there are 1.4 million non-profits in the US. Figuring this problem out will result in a huge increase in sales for the firms that provide this service.
- They can’t purchase a system in cash, because they don’t have a tax apetite, so financing is a natural fit for them.
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