Developers of small to mid-sized commercial and industrial projects, those under 300 or 400 kW, are often tempted to think about power purchase agreements (PPA) and partnership flips as the one-size-fits-all financing solution for solar projects, says Christopher Lord, instructor of HeatSpring’s Solar Executive MBA Training course.
The reality is that such structures are generally too complicated and costly to justify for small to mid- sized solar projects. That’s why it makes sense to ensure you have other options in your financing tool kit.
Financing options generally take advantage of tax benefits available in the first five to six operating years of a project. They also focus on the operating cash generated by selling solar power to a host customer, generally a commercial or industrial business.
Tax Benefits Help Solar Compete with Utility Power
Usually, the tax benefits are used to help offset the cost of the solar project, and make the cost of power low enough to compete with utility supplied power. But not all commercial and industrial customers can utilize the tax benefits. In that case, the customer can enter into a PPA with a third party who will own the solar project and use the tax benefits to lower the cost of power to a price competitive with, or even less than, the cost of utility power.
A partnership flip allows two or more investors to own a project together so that one gets most of the tax benefits and the other gets most of the cash benefits. It’s called a partnership flip because in the first five years or so, the tax investor “owns” a majority of the project benefits, and then after the fifth year, when the tax benefits have all been realized, the “ownership” of the project flips to give the cash investor the majority of the remaining project benefits. The flexibility of the partnership flip opens the door for more investors to support solar.
Partnership Flips are Complex, Often Too Complex
There’s one catch: Partnership flips are detailed and complicated. Failure to comply with all of the requirements – even just one seemingly small detail– can irrevocably destroy the tax benefits. Documenting a partnership flip properly to guard against the loss of tax benefits means hiring expensive lawyers and accountants. Small to mid-sized transactions don’t have enough margin in them for a developer to afford that level of professional services.
Instead, developers should look for a single party, perhaps a high-net worth individual, to buy the project for both the tax and cash benefits of owning a solar project. Or, better yet, two or three individuals can pool their resources and purchase the project through a special purpose entity, such as a limited liability company.
An Alternative to Flips
In that case, each of the owners invests a percentage of the required purchase price and gets back a corresponding percentage of the tax and cash benefits. For example, two buyers might share the purchase price, with one providing 40% of the purchase price and the other putting in 60%. Each then receives an allocation of tax and cash benefits equal to the percentage they contributed.
“This keeps it simple. Everything is allocated and distributed according to membership in the benefit,” says Lord. Each party gets some tax benefits and each receives some of the income and cash benefits of the project and the deductions. Keeping things simple helps cement the deal.
Keep it Simple and Avoid Complex Flips
Lord advises developers with small to mid-sized projects to avoid the complexity of partnership flips. Instead, focus on finding investors who are willing to receive a straight allocation from the pr;oject.
“That way, there are no flips, there’s much less complexity, and you are more likely to complete the deal,” says Lord.