How to Price the Risk of Cash Equity vs Tax Equity Positions in Solar Partnership Flips

This article is part of a series 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. The 6 week class teaches solar professionals how to finance commercial solar projects from start to finish including financial modeling, legal contracts, development tools, and a capstone project.

Now, onto the question.

In a partnership flip, just how much riskier is the Cash Equity position, compared to the Tax Equity position? How do you put an IRR or Discount on that?

In a partnership flip, the cash equity’s return is subordinated to the tax equity’s return. In other words, the lion’s share of all cash and tax benefits for a project are allocated to the tax equity, with only a small allocation to the cash equity. This continues until the tax equity achieves its target return. That target return could range from an upper single digit return for the best of the best projects, and more typically in the low to mid double digits for typical mid-sized DG projects. This allocation favoring tax equity could extend for anywhere from 3 to 10 years depending on the strength of the project’s economics. Only after the tax equity realizes its target return, does the allocation of cash (and tax) benefits swing back to strongly favor the cash investor. This means that cash equity returns are pushed back later into a project’s lifecycle, and that longer term and subordinated role mean a cash equity position is always “riskier” than a tax equity investor and ought to receive a return greater that than the tax equity investor.

How do you put an IRR or Discount on that?

Hard for a developer to put a price on it, but the real test is what kind of a return does the market require.