Obtaining financial backing for a solar project is often the key to success; however, the vast majority of projects are not financeable without adhering to a few rules that make a project secure and attractive for the long term. Here are some simple guidelines to help developers design and structure financeable deals:
1. Lock in the revenue stream: Project financiers are not speculators or traders. They look for revenue certainty. They are generally comfortable analyzing and accepting technical and production risks, but shy away from market risk. In order to attract project-level capital it is necessary to lock in energy sales under a long-term, fixed-rate power purchase agreement, lease, or similar off-take arrangement. Debt providers in particular will for the most part not underwrite non-contracted energy or SREC sales even in circumstances where a stable market exists. The only partial exceptions we have seen to this rule are (i) long-term contracts that float with an index (e.g., at a fixed discount to the local utility rate), but only if there is a fixed floor, in which case the financier will only underwrite to the floor; and (ii) the Massachusetts (US) SREC program, which is supported by a state auction mechanism. In the latter case, a small number of financing parties are comfortable either underwriting to a very low SREC price or underwriting to the auction price with outsized reserves.
2. Structure for the long term: Solar arrays are long-lived, capital-intensive infrastructure assets. Most systems are assumed to have a useful life of 30 to 35 years, and some existing systems have been operating for over 50 years. Project financiers are long-term investors that are comfortable with this type of asset profile. However, it takes a long time to recover capital and earn an acceptable return on investment. We generally therefore require 20- to 30-year contracts. It’s very difficult to make the numbers work with contract terms of less than 15 years.
3. Pay attention to the numbers: The project financial model is the single most important tool used by project financiers to analyze investment opportunities. The project model should be cash-based (as opposed generally accepted accounting practices), reasonably conservative and very detailed. Far too often, we see models that are missing basic elements, such as property taxes or annual audit fees. Some models overstate production estimates and/or underestimate construction or operating costs, etc., which, when corrected, render the project economics unworkable. Developers need to take time to identify and properly model all aspects of a project’s economics prior to locking in a power purchase agreement (PPA) rate or engineering, procurement and construction (EPC) price.
4. Use proven technology: Project financiers are generally fairly sophisticated when analyzing technological risks (and are often advised by independent engineers), but they are not technological risk-takers. New technology isn’t necessarily a non-starter (one thing that can help is to get an engineering firm to perform an independent assessment of the equipment), but it will make it much more difficult to attract capital for the project.
5. Create a good data room: Project financiers have extensive due diligence requirements and limited amounts of time. It is therefore critical for them to be able to analyze a project efficiently and render quick decisions. A fully populated, well-organized data room makes this process much more likely to be successful. A data room can be an actual physical place where bidders go to receive restricted information or it can be a virtual data room, which is a secure location on the internet.
6. Know the market: All project investors have minimum return on investment(ROI) requirements. The latter are driven by the level of risk inherent in the project and the type of investment being considered (e.g., senior secured debt, mezzanine debt, tax equity or permanent project equity). Project investors will not readily reveal their return requirements, so it is up to the developer to understand the market and structure deals that are financially attractive. Regardless of financial structure, a good rule of thumb is that unleveraged pre-tax project-level returns should be in the mid to high single digits.
7. Line up your ducks: Developing a solar project of any size is a long and challenging process. A developer is much more likely to create value for him or herself by taking time to do things right and by getting as much done as possible before approaching financing parties. All financiers will say that they like to get involved early, but the reality is that financiers aren’t able to spend a lot of time on projects that aren’t fully developed. The closer a project is to construction-ready, the more likely it is to attract the interest of investors.
8. Don’t be greedy: Project finance is all about lowering capital costs by managing risk. Long-term financiers and project owners are seeking to make a stable return over a number of years. Project economics are generally thin. Developers need to have realistic expectations of what investors can pay and work to make the deal feasible for both parties.
Written by Phil Henson, Chief Financial Officer at Main Street Power, based in Boulder, Colorado (US).