Since we started running our online Solar Executive MBA course—which teaches experienced solar professionals how to finance commercial solar projects—we have received a large volume of questions about financing non-profit solar projects. In this Q+A session course instructors Chris Lord and Keith Cronin answer 5 questions about due diligence, crowdfunding, and finding investors to finance nonprofit solar PPAs.
You may also be interested in our 60-minute recorded Q+A session that answers 7 questions about financing commercial solar projects.
The Five Questions 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 PPAs, 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?
Perhaps the first 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. Finding tax equity investors is usually more challenging. The amount of time to closing can vary greatly and depends upon a deal’s characteristics and competing deals with higher returns and lower risks.
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, who could become 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, contact your local lending institutions to see who is doing deals. They usually know what is happening at loan origination or in their leasing departments (which are often now referred to as Equipment Financing). They will have access to contacts and it is those relationships that you will want to foster.
Approaching investors can come in a variety of ways. Offtakers for a for-profit business are going to look at all the documents related to the project and the company background. Often 3 years of audited financials of the company/host is 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. It is also critical to consider the type of business and its long-term goals. PPAs typically last 15-20 years. 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?
The amount of time this process can take can varies. 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 1920s capital markets right before the market crash of 1929. As a consequence of these rules, sophisticated 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 crowdfunding. Crowdfunding 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 percent and probably average between 6 and 7 percent in today’s market—can still greatly enable a project.
One of the leading crowdfunding platforms for solar projects is Mosaic. Here is how Mosaic works. Mosaic performs due diligence on the project, and, if the project meets its threshold requirements, will enter a funding agreement pursuant to which Mosaic lends the project $X at an agreed upon rate and term. Mosaic then raises money by posting the project investment opportunity on its website. Effectively, 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 maximum and minimum). Once the full amount has been raised, the transaction is closed to further investors.
Crowdfuning can work particularly well for non-profits because it provides “affinity investors” an opportunity to participate in a carefully structured transaction and benefit from the due diligence and data gathering performed by a company like 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.
Crowdfunding 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 down side of crowdfunding 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 crowdfunding 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 who 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. Sometimes non-profits don’t have a long track record and could also cease business operations. As an example, even in a house of worship, a leader in the organization, like a pastor, could leave and take the flock with him to another location, emptying the church and its operations. This will adversely impact an investor and is a risk that should be considered.
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 sources like a rental property. If you incur losses from a business but aren’t an active participant in the business, that is considered passive income.
The challenge is that most individuals don’t earn much passive income. This is a long-standing issue 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-profit clients and potential investors for those projects?
Due diligence can be lengthy and can also be brief. We like to get as many details as possible about a project, but, in local markets, the vetting process for smaller projects is often relationship-based.
It is also desirable to set up an online data room to effectively store and manage documents and correspondence during this process. This keeps everyone informed and up to date with the latest document revisions and limits the need to dig through your email inbox for information.
Developing a detailed process for gathering this information is essential. Having a framework will enable your team to work efficiently and collaboratively and will be attractive to prospective investors. Investors often know others who are in the market for these types of opportunities, and creating a standardized template listing the requirements of all parties 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 effect on their projected returns and can make a deal un-financeable.
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 versus 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. Utilities are heavily regulated entities, and—like all monopolies—jealously guard their turf. So, as a general rule, PPAs 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 states permit third party PPAs where the power is produced and used on site, but they do so under different schemes. For example, in California, PPAs are permitted in all investor-owned utility jurisdictions. Most municipal utilities either don’t permit PPAs or limit how power may be produced and sold within their service territory. For example, the Los Angeles Department of Water and Power (LADWP) 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 PPAs are not permitted, leases can and often do work. Under a lease, an electricity user leases a solar system from a leasing company. The user then uses the solar system to generate and deliver solar power for their own use. (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 (O&M) 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 kWhs delivered by the system. That variability is important because if a solar system under-performs or unexpectedly breaks, the risk and cost are all on the project company/investors.
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.