How to Pay For Commercial Solar Financing
At Solar Earth Inc, we understand that financing is one of the biggest challenges in getting started with a commercial solar project. Fortunately, there are many options available to help businesses of all sizes access affordable solar financing. Let’s explore some of the most popular commercial solar financing options and tips to help you to choose the best one for your needs.
In commercial solar sectors, there exists a diverse range of avenues through which a project can attain financial backing. Among these avenues, some of the most commonly encountered include solar power purchase agreements (PPAs), solar leases, energy services agreements, tax equity financing structures like sale-leasebacks and partnership flips, and direct cash or loan acquisitions of the solar system. An in-depth examination of each of these methods follows.
To begin, let’s delve into PPAs and leases, which stand as two of the most prevailing choices for funding commercial and industrial (C&I) solar ventures. As elucidated in our comprehensive guide to solar financing alternatives, both PPAs and leases involve the photovoltaic (PV) system’s ownership with a third-party financier. This ownership extends beyond the solar developer or the end-user who will consume the generated power.
The third-party proprietor becomes the beneficiary of tax incentives linked to the system, including but not limited to the 30% Federal Investment Tax Credit (ITC) and depreciation allowances. These economic benefits can subsequently be conveyed to the customer through the rates offered, rendering this option particularly attractive to customers possessing minimal or no tax liability—examples being nonprofit organizations. Nevertheless, within the frameworks of both leases and PPAs, the commercial client might be able to procure the PV system at specific junctures during the contract period or upon its conclusion.
Power Purchase Agreements (PPAs) Within the framework of a PPA, the solar customer agrees to procure the solar energy generated by the photovoltaic (PV) system from the system proprietor at a predetermined price, spanning a specified number of years. The duration of a PPA typically spans between 10 to 25 years.
Throughout the history of commercial solar endeavours, the solar power purchase agreement (PPA) has consistently held a prominent role in project financing. As Holloway underscores, within the commercial and industrial sector, PPAs remain “the foremost source of funding as far as my knowledge extends.”
Furthermore, the capacity for entities with limited tax liabilities to indirectly access the advantages of tax incentives through another entity has significantly contributed to the widespread adoption of PPAs. Holloway notes, “Nonprofit organizations, as well as other entities ineligible for the Investment Tax Credit—such as schools, municipalities, churches, and charitable institutions like Boys and Girls Clubs—find themselves unable to directly benefit from the ITC. They require a surrogate to avail themselves of these benefits, and a PPA emerges as one of the few financing mechanisms at their disposal.”
PPAs enjoy popularity for several other reasons. One notable feature is their potential to be structured without the customer’s initial payment requirement (i.e., no upfront payment). Moreover, the extended term of specific PPAs (e.g., 25 years) can facilitate lower payment obligations.
It’s also possible to structure PPAs with an escalator clause, wherein the price paid by the customer for the procured energy experiences incremental increases over time. For customers aiming to optimize their initial savings, escalators offer a means to attain reduced costs at the commencement of the contract.
Considerations Regarding PPAs
In cases where an escalator clause is integrated into the agreement, customers should meticulously assess how the escalation rate aligns with historical rate hikes from their utility provider. While foresight into the future trajectory of utility rates is impossible, it remains crucial for the escalator to be grounded in reasonable projections of forthcoming rate increases. This approach mitigates the risk of customers paying more for solar energy in the future than they would have incurred by sourcing power from the conventional grid.
Leases are another prevalent avenue for financing commercial solar ventures, bearing several resemblances to PPAs. Much like PPAs, a third-party financier owns the photovoltaic (PV) system, and the arrangement can be structured to exclude any initial payment requirement.
Nevertheless, compared to acquiring the actual power output at a per-kilowatt-hour rate, as seen in a PPA, a solar lease entails the customer making steady payments over a predetermined span. While these fixed payments are formulated based on the system’s projected output and estimated value, they are not directly contingent upon the system’s production.
Unlike the seasonal fluctuations in a customer’s solar bill under a PPA, which would entail lower expenses during periods of reduced system output, a customer with a solar lease can expect consistent payments regardless of production fluctuations. This predictability offers stability and cost-planning opportunities. On the flip side, in cases where production falls below expectations due to factors unrelated to system malfunctions (e.g., an abnormally rainy year), the customer’s bill won’t proportionally decrease.
Similarly, escalator clauses, commonly found in many PPAs, are not included in leases due to the predetermined nature of lease payments.
Types of Leases: Operating vs. Capital
Leases Two categories of solar leases exist, each carrying distinct accounting implications for businesses: operating and capital leases. While a comprehensive examination of the complete accounting ramifications of working versus capital leases extends beyond the confines of this article, a primary differentiation between the two lies in the fact that operating leases do not find a place on the company’s balance sheet, whereas capital leases do.
As Holloway clarifies, “In the [C&I solar] sector, most companies predominantly opt for operating leases, as capital leases become part of your balance sheet. Companies generally lean towards keeping a significant portion of their financing off the balance sheet to limit their borrowing capacity.”
An operating lease more closely resembles equipment rental, while a capital lease bears similarities to a loan, encapsulating certain advantages and risks associated with ownership.
The duration of a solar lease encompasses a broad spectrum, ranging from as few as seven years to as extensive as 25. Nevertheless, commercial solar leases frequently span shorter periods than commercial solar PPAs. Holloway notes, “While the possibility of extending the term of Operating Leases exists, this presently deviates from industry norms. From my experience, the overwhelming majority of operating leases still fall within the 7-10 year timeframe.”
The lease duration significantly influences the customer’s payment commitments. Holloway elucidates, “If the amortization window for these payments is limited to seven or ten years, the ensuing payments will notably exceed those of a lengthier agreement.”
Energy Service Agreement
Energy Service Agreements Another form of commercial solar financing akin to an operating lease is an Energy Service Agreement (ESA). As the American Council for an Energy-Efficient Economy articulated, “Under an ESA, a service provider furnishes energy-saving services utilizing equipment under its ownership and operation.” Analogous to an operating lease, this constitutes a variant of off-balance sheet financing, rendering it popular among enterprises.
Although legally distinct from leases, ESAs correspondingly share characteristics with operating leases, wherein the customer remits a fixed fee for the “service” of solar energy (albeit ESAs can also fund various other enhancements in building energy infrastructure). In many instances, the ESA provider guarantees a predetermined level of energy conservation.
Chase elucidates that numerous corporations—especially those managing multiple locations or property portfolios—frequently adopt energy service agreements as a risk-free strategy to finance multiple energy enhancements, ultimately securing a savings guarantee.
Solar Success: Sale Leasebacks & Partnership Flips
As evident from our discussions on leases and PPAs above, the concept of “tax equity” in a solar project—that is, the capacity to offset tax obligations by leveraging specific policy incentives such as the Investment Tax Credit (ITC)—holds substantial value for entities with sizeable tax liabilities that can capitalize on it.
Although tax equity is significant in various solar financing methods like PPAs and leases, distinct financing arrangements have enabled certain groups with substantial tax obligations (tax equity investors) to harness a project’s tax equity in return for investment.
These tax equity arrangements constitute a specialized facet of solar project finance, encompassing structures like partnership flips and sale-leasebacks. While the intricacies of these setups are too intricate to explore in this article thoroughly, we will provide a concise overview of these mechanisms and their fundamental workings.
In a partnership flip scenario, the arrangement is structured so that the tax equity investor receives a predominant share (e.g., 99%) of the project’s income allocation for a specified duration—specifically until the period of ITC recapture has concluded. Following this juncture, the contract outlines a “flip” of their allocation, enabling them to either exit the partnership through a buyout or remain in the league while receiving a minority portion (e.g., 1%) of the project’s income and cash allocations. The majority of budgets then transition to the project sponsor.
As Holloway elucidates, “The objective of the tax equity partner is to monetize nearly all of the tax advantages. Their aim is not to maintain ownership of the asset in the long run… [only to] be a partner in the venture until the benefits of tax equity—such as ITC and depreciation—have been realized.”
“At that point, the tax equity partner ‘flips’ out of the arrangement; they shift from holding, for instance, a 99% income allocation to 1%. Subsequently, the sponsor assumes a 99% allocation and commits to the long-term venture.”
Partnership flips represent one of the most prevalent forms of tax equity financing in the solar domain.
In a sale-leaseback framework, the tax equity investor acquires the photovoltaic (PV) system from the project sponsor. Subsequently, they lease the system back to the sponsor, who retains the privilege to operate and utilize it and receive revenue through its operation. The sponsor has the option to purchase the system at a designated point.
Transaction Costs Influence the Utilization of These Financing Approaches
Solar project finance deals of this nature bring together diverse parties with distinct interests and objectives in a project. The negotiation of legal terms acceptable to all parties can entail significant expenses. Chase outlines, “Due to the involvement of numerous parties, securing this form of finance incurs high transaction costs.”
Such elevated costs generally render these deals viable only for large projects exceeding a particular threshold value. Alongside the substantial commercial sector, these financing structures are well-established in utility-scale projects; however, they must be more practical for numerous smaller commercial undertakings.
Commercial Solar Financing Loans
Solar loans are another popular financing option for businesses looking to invest in solar energy. A solar loan allows a business to borrow money to buy and set up solar panels. Then, the company repays the loan with interest over time.
The advantage of a solar loan is that the business owns the solar panels and is therefore eligible for any tax incentives or rebates available for solar energy.
Furthermore, businesses have the flexibility to customize solar loans to match their specific requirements. This includes deciding on the duration of the loan and the interest rate.
Green bonds represent a novel financial instrument for corporations aiming to funnel resources towards eco-friendly ventures, like solar power. Issued by entities displaying a steadfast commitment towards environmental sustainability and responsibility, these bonds are tailored to raise capital for undertakings that yield a positive ecological influence.
Investing in green bonds can provide significant financial benefits for businesses, including a fixed interest rate and the potential for tax benefits. In addition, green bonds can be a way for businesses to demonstrate their commitment to sustainability to customers and stakeholders.
Tax Credits and Incentives
Enterprises that opt to invest in solar power may qualify for tax reductions and incentives. Specifically, the federal Investment Tax Credit (ITC) grants a 26% tax credit to firms that install solar panels until the conclusion of 2022.
Furthermore, numerous states proffer supplementary inducements such as reimbursements, endowments, and tax reductions for enterprises that elect to allocate funds toward solar energy. By utilizing these tax credits and incentives, companies can reduce the expenses associated with their solar project and attain a quicker return on investment.
Debt Solar Financing (Loans)
In addition to the array of financing avenues mentioned above, where ownership of the PV system is vested in entities other than the solar energy user (at least temporarily), commercial solar clients have the option to secure their PV system through purchase—either outright (with cash) or using a loan.
In such instances, the tax advantages are directed to the customer. Given the clarity of cash transactions, we will discuss solar loans. Solar loans share similarities with other loan types you might be familiar with daily.
Debt Financing Types
Diverse Forms of Debt Financing Several loan categories exist, encompassing secured loans tied to the lessee’s assets and unsecured loans that lack such collateral. For clients amenable to leveraging their assets, such as real estate property, as security, secured loans can yield preferable rates or even enable access to loans that might otherwise remain elusive. Ownership of the building is a prerequisite for this option.
Moreover, another form of debt financing gaining traction in certain regions is Property Assessed Clean Energy (PACE) financing. Under PACE, loans for solar installations (or other property enhancements like energy efficiency upgrades) are repaid through the property taxes of the project site. PACE is contingent on enabling legislation in specific areas. Still, it can constitute a valuable solar financing avenue—especially considering that repayment periods might sometimes extend up to 30 years.
Consideration Regarding Debt
Choosing the Best Solar Financing Option for Your Business
When determining the ideal financing option for your commercial solar venture, several factors must be taken into consideration. These factors consist of the project’s size, the amount of initial capital you have at your disposal, and your objectives for sustainability and energy independence over the long term.
At Solar Earth Inc, we collaborate closely with our customers to comprehend their distinctive requirements and assist them in selecting the optimal financing options for their enterprise. Whether you are interested in a solar lease, a Power Purchase Agreement (PPA), a solar loan, a green bond, or any other financing option, we are well-equipped to guide you through the choices and assist you in selecting the one that will deliver the most substantial financial and ecological benefits for your business.
Our team of experts can provide you with detailed information on solar financing rates and help you choose the best option that fits your budget and goals. With our support, you can make an informed decision that will not only save you money but also contribute to a sustainable future.
Commercial Financing Proposals
If you’re considering investing in solar energy for your commercial property, we can help you assess the return on investment that a solar energy system can provide. Simply send us a message expressing your interest, and we’ll generate a preliminary financing proposal for you.
Renewable energy is a wise investment for any business looking to the future. Over the long haul, you can save thousands, if not millions of dollars in energy expenses by minimizing or eradicating your reliance on grid electricity. Contact us @(805) 691-8000 today to learn more about how Commercial Solar Financing can benefit your commercial property.
Investing in solar energy can provide significant financial and environmental benefits for businesses of all sizes. With a variety of financing options available, including solar leases, PPAs, solar loans, and green bonds, there has never been a better time to go solar.
At Solar Earth Inc, we are committed to helping businesses access affordable solar financing and achieve their sustainability goals. Contact @(805) 691-8000 today to learn more
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