Financing Commercial Solar
What are the financing options for commercial solar systems?
Introduction to Solar Financing
A well sized Solar PV system can often reduce energy costs by 40% or more and save a similar proportion of the carbon emissions a business generates from its energy use. Such a system for an SME typically costs between £50k and £350k for a single site and so can be a significant expense for a company. For larger companies with multiple sites investment costs can easily exceed this. Some companies have the capital available to invest in schemes directly but for many self-funding a scheme is not an option.
Happily, there are a number of routes that a business can pursue to raise the capital to fund some or all of a proposed scheme from third parties. In many cases it is possible to fully fund a project and pay for the cost of the financing from the savings in energy costs and still see saving of 10-20% of the original energy costs.
When considering any solar scheme, we suggest that you should review the economics of both the self-funded and third party financed options next to each other. As many institutional lenders offer very supportive terms for Solar and other green assets the funding available for solar schemes may be amongst the cheapest and longest dated capital a business can raise.
Financing Options.
Self Funding
For companies fortunate enough to have the capital available to fund the system self-funding is always the simplest option. We have published a detailed guide to The Economics of Commercial Solar which goes into the economics and returns of Solar schemes in some detail and explores some of the key risks and assumptions to consider when assessing returns.
Even companies that are holding cash will want to consider the return on investing in a solar scheme next to the returns that they could make investing this cash elsewhere when making their decisions.
Grants
A number of grants may be available for a business. The range of grants available changes continuously. We have published a guide to Grants for Commercial Solar which has detailed information on the grants that are currently available in the UK. Generally, grants will fund 25% to 50% of the cost of the project and may impose limits on the kind of financing that can be used to fund the balance of the project. Grants are usually paid once the project has been installed and so the company will need to be able to fund the construction of the system and the grant will be paid retrospectively.
The complexity of the grant process varies depending on the council or other authority administrating the grant but other than the need to go through the process there are very few downsides to applying for a grant where they are available as long as they don’t impose significant restrictions on how the balance of the system if funded.
Asset Finance (Finance Leases or Hire Purchase.)
Most businesses are familiar with the concept of asset finance as the structure is used for everything from trucks to photocopiers. Although legal details differ all asset finance structures are generally most easily understood as a loan to fund the purchase price of the asset. The business “borrows” the money to pay for the installation and agrees to repay fixed amounts over a predetermined period (the term) to repay the “loan”. The most common form of Asset Finance for a Solar System is a Hire Purchase Agreement where the legal ownership of the system stays with the lender until the term of the financing has been completed at which point the business can acquire the system for a nominal payment. Some lenders prefer to use a Finance Lease structure which is operationally and contractually very similar to a Hire Purchase Agreement, however the businesses cannot acquire the asset at the end of the term but instead the lessor will usually allow the lessee to lease the equipment in perpetuity for small nominal payment which commercially is an identical outcome.
The tax and accounting of HP Agreements and Finance Leases are identical, and business are generally treated as acquiring the asset at the time the agreement is entered into and so pays VAT on the acquisition but can claim writing down allowances on the investment. We have published a guide to Tax and Accounting for Commercial Solar which explores this subject in more detail.
Historically Asset Finance has been available for a term of up to five years. In the last few years lenders have increasingly recognised the long life and robustness of Solar Systems and so terms from 7 to 10 years are common with some lenders allowing terms out to 15+ years for businesses with good credit standing.
Pricing for Asset Finance funding will depend on term and the credit standing of the business purchasing the solar system but we currently see APRs ranging from 8% to 13%.
Advantages and Disadvantages of Asset Finance for Commercial Solar
Asset Finance is a simple and well understood approach for businesses to take when funding an investment. This means that for schemes with a value below around £200k they tend to be the obvious route for a business to take if they are not self-funding. The legal costs of PPS tend to be prohibitive below this level.
Asset Finance terms have improved significantly over the last couple of years and the availability of longer dated loans for some companies make these facilities much more competitive with PPAs.
Most businesses should be able to get a range of quotes to be able to compare terms and prices.
As with all credit there is a cost of borrowing money and this needs to be weighed against the opportunity cost of a business using its own resources to fund the project.
Power Purchase Agreements (Operating Leases)
A PPA is a model in which a business (tenant, landlord or owner occupier) leases the airspace above its roof to a provider who pays for and installs the panels. This PPA provider sells the solar energy back to the business at an agreed price which is typically considerably lower than available market prices.
Typical terms are 15-25 years, however some flexible PPA providers can offer shorter agreements to match lease lengths of the property where the system is to be installed.
The model is legally more complex than an asset finance transaction and so generally suited to larger projects for companies consuming more than 250 MWh/ year.
Whilst the legal model is more complex operationally it is simpler for the business as the PPA provider takes responsibility for the installation, consents, monitoring and maintenance of the system.
The business will need to agree to pay for a minimum level of electricity consumption at an agreed price for a certain duration, but this is treated as an operating cost rather than a loan payment.
The cost of the system may not recognised on the businesses balance sheet and the committed payments are typically treated as an expense. If the company has existing debt the PPA agreement may not be included in any financial covenants - depending on how these are drafted.
Advantages and Disadvantages of a PPA
Historically PPA providers have been able to access longer term financing than a typical operating company was able to find from Asset Finance Providers. This meant that year one savings is typically higher although the whole life cost of the arrrangement may be higher because of the “embedded” financing charge. The market is fast evolving so longer dated Hire Purchase agreements are available to more businesses. This means that the decision between PPA and Hire Purchase may come down to whether it is better for the company to have the asset and debt on their balance sheet and benefit from the associated writing down allowances or whether it makes more sense to have the more flexible approach that may be possible with a PPA.
Some companies will prefer the transparency of the Hire Purchase Agreement and want to ensure they are getting good value for each component of the project, installation, financing and maintenance whereas others may prefer the operational simplicity of a PPA where a single counterparty manages all of these different aspects of the system.
Unsecured funding (General Corporate Borrowing)
Occasionally it may make sense to fund some or all of a scheme from general purpose borrowing. This borrowing is usually more expensive and has a shorter term than Asset Finance or Power Purchase Agreements and is likely to only make sense if part of the project is funded with a grant that specifically prohibits the use of Asset Financing to fund the balance of the project. Although this type of funding is not legally linked to the asset it may be possible to terms that are better than a general corporate facility from certain lenders because of the use of funds.
Advantages and Disadvantages of Unsecured Funding
Specialist financing will nearly always be more economic than unsecured funding so the only reason to use this type of funding is if it is a requirement of a grant which more than offsets the economic benefit of using Asset Backed or PPA based financing.
Key factors to consider when selecting third party funding
Most people consider cost to be the most important consideration when selecting the right financing for a scheme.
To do this properly a company will need to consider whether its objective is to create immediate operational savings for the business, in which case a facility with a longer term may be most appropriate even if it has a higher interest rate as the monthly repayments will be lower even if the whole life cost of the loan is higher. Alternatively, a company may be looking to generate the most value over the life of the system in which case a shorter, cheaper loan could offer better value as the whole life cost will be lower.
The balance will depend on the “time value of money” for the company so a discounted cash flow analysis is necessary to establish which solution will deliver the optimum outcome for the business.
In addition to economic optimisation, we suggest a careful review of the loan terms is important. In particular it is necessary to understand what happens if things change and you want to repay the loan early and any other obligations you take on in addition to the repayments.
It is also important to see the financing in the context of the companies broader position. For companies with existing debt facilities who need to report against leverage covenants a PPA agreement which is an operating lease and keeps all of the financing “off-balance” sheet may be attractive. Alternatively, companies paying tax who are not making full use of the Annual Investment Allowance will benefit from generous writing down allowances which can significantly improve the economics of Asset Finance or self-funded installations.
Case Study: Elm Valley Foods
Elm Valley Foods is a wholesale food distributer in Suffolk. As a distributor of chilled and frozen goods they operate large fridges and freezers in their warehouse.
Elm Valley worked with GreenHearth to arrange financing for a 50kWp system. They successfully applied for a Rural Development Grant organised through Babergh and Mid Suffolk District Councils under the Government’s Levelling up Programme and funded the balance using a 10-year Hire Purchase Agreement with an APR around 11%. The system is expected to save around 15% of the company’s energy costs, after the cost of finance, in its first year and to save the company around £125k over an assumed 20-year life.
Giles Prime the Finance Director of Elm Valley said “using the combination of grant and asset finance meant we could install the system without delaying other investments. We are saving money in the first year and have nearly halved our carbon emissions from energy use.”
Conclusion
The rate of installation of Solar PV systems on commercial and industrial rooftops in the UK has lagged behind domestic and industrial field scale schemes. This is often because businesses do not have the capital to invest or the band width to understand the complexities of the solar and financing markets and make a sensible economic assessment of the proposed project. There are now a range of financing options available to fund these projects and firms like GreenHearth can help you understand the overall economics of a proposed system and help you find the best financing for your circumstances.