(Credit: EnFlux Building Solutions)
Your company’s budgeting cycle just ended and once again, efficiency projects were delayed another year. The projects didn’t meet internal return hurdles – however, all is not lost. Some large businesses allow efficiency projects to be undertaken outside of the budgeting process if the financing structure meets certain guidelines. These financial structures provide what I refer to as “friendly capital.”
The C-PACE finance program can be a friendly capital alternative for those Fortune 1000 businesses whose facility operating costs remain unnecessarily high – which is often the case.
Although this is written from the building owner’s perspective, its message should also resonate with ESCOs and contractors who have all been challenged in convincing customers to invest in efficiency projects.
Why Efficiency Projects Are Often Excluded from the Budget for Fortune 1000 Companies
My perspective on this topic was gained while running a structured finance team for a large energy services company. We targeted Fortune 1000 C&I businesses and delivered services through bundled energy service agreements. Replacing old worn out HVAC, lighting and similar equipment was a major component of our offering. How our customers absorbed the costs of the new equipment would require the attention of a senior member of the company’s finance team. In those meetings, we were often told, “We realize these projects will reduce operating costs, but the returns just aren’t there. We have other revenue generating projects which provide higher returns.”
Quite often the customer’s project savings assumptions were way too conservative. After a bit of arm wrestling, they would sometimes change their approach. However, too often they didn’t, and in those cases, I needed to develop another approach. I eventually stumbled upon it when I recognized a recurring theme in conversations with these companies.
Friendly Capital
Some companies had “carve-outs” that would allow efficiency projects to be funded outside of the normal budgeting process if certain financing guidelines were met. In other words, there was greater latitude to enter into efficiency projects when using friendly capital as described in the first paragraph.
As a structured finance geek, this got my juices flowing. We deployed every conceivable structure, and even invented some, to finance efficiency projects. However, without question, we would have closed a lot more projects if C-PACE had been around.
C-PACE could be the friendly capital you’ve needed for efficiency projects.
Why do I say this? It’s best explained with the examples provided below. If you’re unfamiliar with the C-PACE program, see Addendum A at the end of the article.
Examples: How Is C-PACE is Friendly Capital?
Following are three examples of financing guidelines that allow some companies to enter into efficiency projects outside of the normal budgeting process, and a description of how C-PACE addresses those requirements.
1) 100% Financing — No Parent Guarantee
Financing guideline: only projects financed 100% with no parent guarantee can be undertaken.
C-PACE: 100% of the project costs can be financed with NO parent guarantee.
Side note: This is also quite attractive to small businesses whose owners often feel their business is self-supporting and do not want to place their personal holdings at risk with a debt guarantee.
2) Projects Needs to be Self-Funding
Financing guideline: the project must be self-funding – meaning project debt must be serviced entirely by energy and maintenance/repair savings in the case of efficiency projects.
C-PACE: This is where C-PACE really stands out. Since funding is repaid over 20+ years, annual payments are very low and easily covered by annual energy and maintenance/repair savings as shown in the example below.
When C-PACE is used for virtually any pure efficiency retrofit, EBITDA and net cash flow will increase!
Simple payback of ~7 years.
This shows how the expected $70,000 per year of annual Total Savings easily covers the $42,984 annual C-PACE payment.
3) Efficiency Financing cannot include Typical Lender Requirements
Financing guideline: the financing agreement does not provide protection to the lender such as cross-acceleration/cross-default, financing covenants, burdensome reporting requirements, and other affirmative or negative covenants.
C-PACE: does not require any of the above protections.
How C-PACE Addresses these Requirements
Below are some of the rights of lenders for traditional debt financing which C-PACE does not require.
Full acceleration rights/cross default: The C-PACE lender does not have the right to accelerate the full unpaid balance, even if a scheduled payment is missed. Only the unpaid amount that has been billed but not paid, is recoverable.
Financial covenants: Large companies enter into financial arrangements which provide covenant protection to their primary lenders. They would be reluctant to allow a subsidiary to finance a relatively small efficiency project and give that lender the same covenant protection with voting rights for amendments/waivers, etc. C-PACE lenders do not require such covenant protections.
Quarterly reporting: The financing cannot require time consuming oversight from the corporate treasury group. After the deal closes, the company simply pays the annual or semi-annual C-PACE assessment at the same time their property taxes are paid. That’s all they have to worry about.
Restrictions such as allowed distributions, asset sales, and incurring other debt: If a large company is looking to make a distribution, sell an asset or incur additional debt, they must ensure this does not violate any covenants in existing credit agreements. For those with a large number of lenders in numerous credit facilities, this can be quite an undertaking especially if a waiver is needed. Since the C-PACE lender does not have any of these covenants, it can’t complicate the process.spa
(Two more examples of friendly capital are in Addendum B below, which covers off-balance sheet financing and savings guarantees. Both can help efficiency projects be approved outside of the normal budgeting process.)
Final Thoughts
Efficiency projects often do not meet return hurdles in the budgeting process for many Fortune 1000 companies.
Some of these companies allow various investments (including efficiency projects) to be undertaken outside the budgeting process if funded using a friendly capital structure.
The C-PACE funding structure is quite unique and provides the friendly capital that often meets these guidelines.
ESCOs and contractors can offer C-PACE to their customers thereby providing attractive financing and thus closing more efficiency projects.
C-PACE provides 100% financing repaid over 20 – 30 years.
When using C-PACE, virtually any pure efficiency project is self-funding – annual project savings more than offset debt service. EBITDA and net cash flow actually increase.
C-PACE does not include typical lender requirements such as full acceleration or cross-default rights, financial covenants, quarterly reporting requirements or restrictions on distributions, asset sales or other debt arrangements.
By Larry Derrett, Founder & CEO, EnFlux Building Solutions
Addendum A — The Basics of C-PACE
C-PACE is a source of private capital which stands for Commercial Property Assessed Clean Energy. C-PACE programs have combined to fund 2,000 energy efficiency, renewables and resiliency projects throughout much of the US.
Currently active in 22 states, C-PACE is a unique form of funding repaid through an assessment (similar to a property tax) which becomes an attachment to the building and added to the owner’s property tax bill. The program is established at the state level by statute and is adopted by legislation sponsored by the local taxing authority.
Addendum B — Off-Balance Sheet Financing and Savings Guarantees
Off-Balance Sheet Financing: these financing structures were clearly one of the most commonly seen examples of friendly capital. However, given the recent changes in accounting standards, off-balance sheet treatment is much more difficult to achieve today. Today’s accounting guidelines are governed much more by specific contractual issues between the ESCO/contractor and the customer. This is quite a contrast from the past when off-balance sheet financing was driven much more by the nature of the financing which was often embedded in an energy services agreement.
I’m not at all saying today’s off-balance sheet requirements can’t be met. It’s just much more difficult today. See Embedded Leases ASC 842 to learn more. Please feel free to contact me if you would like to discuss but, in any event, EnFlux does not offer accounting advice and you should consult with your auditors.
Savings Guarantees: these are not really a financial structure, per se, but can be important in obtaining buy-in from financial decision makers. When large business go through the budgeting process, they determine which investment opportunities have the highest risk-adjusted rate of return. If an ESCO/contractor is willing to guarantee a certain level of project savings, it eliminates much of the risk of a company undertaking efficiency projects (except for the creditworthiness of the ESCO/contractor).
This makes it much easier for large companies to agree to projects which are financed 100% and the guaranteed savings are high enough to service the financing costs.
The concept of savings guarantees was excluded from the above as it is not a financing technique. A savings guarantee can be provided for in separate contracts. Placing the impact of savings guarantees in this addendum by no means suggests it is a less important consideration in motivating large businesses to undertake efficiency projects.