This article is part of a series tutorials, interviews and definitions around commercial solar financing that is leading up to the start of our next Solar MBA that starts on Monday September 15th. In the Solar MBA students will complete financial modeling for a commercial solar project from start to finish with expert guidance. The class is limited to 50 students, but there are 30 discounted seats.
This article is part of a series on common topics and questions that professionals have about financing commercial solar projects.
Chris Lord of CapIron provided some insights into pricing certain types of investor risk in partnership flips. Chris is a co-teacher of our Solar Executive MBA that teaches professionals how to finance commercial solar projects from start to finish. The 6 week class involves working a project from beginning to end with expert guidance including legal contracts, financial modeling, and development timelines. You can get your $500 discount on the Solar MBA here.
Now onto the question.
How do you calculate a buyout price for your host customer if they want to purchase the system in Year 7 or Year 5?
You are trying to determine what an investor will want to sell the project for. An investor would take the remaining cash flows from the project for years 8 through the end of the PPA, and discount that stream back to Year 7 using the investor’s target IRR. This will give you an approximation or guide to what FMV might look like in year 7.
What about a residual? How does that play in?
Project sellers love residuals, but buyers never do. A residual value is a guess as to what a project might be worth at the end of the PPA term. For example, if a 20 year PPA had a renewable term, then it would be fair game. Or, if we have a utility scale project and the site lease goes beyond the PPA term, then there is potential value. The question of what that value is, of course, is hard to determine. Moreover, whatever value might be agreed upon, is then discounted back ten or 15 years, which further reduces its role in the ultimate determination of FMV. So, at the end of the day, you can make some residual values, but it is a bit of a guessing game.
What if you want to set the buyout price at the start of the PPA?
Well, that you cannot do if you are seeking to monetize the tax benefits. If there is a firm, fixed price buyout set as a specific dollar amount at the start of the PPA, the IRS might conclude that the tax equity investor is not a true owner of the system because they don’t have any “downside” risk. To determine whether a tax equity investor is truly an “owner” for tax purposes, the tax equity owner must be at risk for losses if the project proves not to be as valuable as the parties thought. Hence the IRS expects you to agree that an option can be exercised for a price equal to FMV, but that FMV price cannot actually be determined until the time of exercise.