Business Model for a Solar Developer
Training purpose only - PDF file
For businesses in India, the solar business model paves the way for financial incentives and opportunities, aligning seamlessly with the nation’s dedication to a sustainable and brighter future for all.
What Are the Benefits of Solar Power to Business?
Many businesses are now tapping into this alternative source of energy, hoping to benefit from its numerous advantages.
Good Return on Investment
Government incentives and the decrease of solar equipment costs means the utilization of solar power is a sound investment and a good financial decision for public agencies and businesses. Investing in solar power generates both long-term savings and quick payback.
You can make money as a solar power developer but you have to choose a viable business model to make your concept work.
This model specifies how income is earned, either by selling the energy generated or by using the electricity produced on-site and saving money. The solar business model affects many aspects, such as who owns the project, how much investment is needed, how operations and maintenance are handled, and what returns the stakeholders can expect. The country has set its sights even higher, aiming for a whopping 500 GW of renewable energy capacity by 2030.
There are two main types of solar business models in India: the CAPEX model and the RESCO model. Each of these models has its own advantages and disadvantages, depending on the specific needs and preferences of the business owner.
Supply and Install Business
Offering to supply and install solar power systems can be a viable business. You quote fixed prices for turnkey installations, and may include financing to address the high initial cost. Your market is homeowners who want to install solar panels and businesses wanting to increase their use of green power. If you have substantial financial resources, you can offer financing yourself, or you can arrange for third-party financing through banks. Your customers are concentrated in areas where, in addition to environmental concerns, they are motivated by the high costs of traditional utility power.
CAPEX Model Explained
The CAPEX model involves the business taking full ownership and responsibility for the solar power system. This means the business purchases the solar panels, inverters, and other equipment upfront to install on their property.
The main elements of the CAPEX model include:
– High Upfront Investment: The business must pay the full capital expenditure (CAPEX) costs to purchase and install the solar system. This requires significant funds upfront but provides complete ownership.
– Long Term Savings: By owning the solar system, the business enjoys lowered electricity bills for decades. Once the upfront investment is recouped, the “free” energy from the sun provides excellent long-term savings.
– Full Control: The business has complete control over the solar system, panels, and maintenance. There is no third-party involvement.
– Tax Breaks: Government incentives like accelerated depreciation and tax credits provide financial benefits that improve ROI on the solar investment.
Overall, the CAPEX model is ideal for businesses focused on long-term savings, full control, and leveraging tax incentives. The major barrier is the large upfront investment required. But for some, owning their own power plant is worth it for decades of nearly free solar energy from the sun.
India's current rooftop solar capacity installations have been almost entirely developed through customer-driven CAPEX and OPEX business models. These business models suffer from several challenges, especially high upfront and transaction costs, high off-taker risks (in case of RESCOs) and performance risks in case of CAPEX, limited availability of finance from mainstream financial institutions, lack of standardized procurement processes, and limited consumer awareness.
OPEX/PPA/RESCO Model
The OPEX/PPA/RESCO model allows businesses to benefit from solar power without the major upfront investment required of the CAPEX model.
In this model, a third party such as a solar energy provider or RESCO (renewable energy service company) will finance, install, operate and maintain the solar power system on your property. As the business owner, you simply pay for the electricity generated by the solar panels based on a predetermined rate and term length outlined in a power purchase agreement (PPA).
Some key aspects of the OPEX/PPA/RESCO model:
– Third party ownership – The solar system is owned and operated by the service provider, not your business. This eliminates the need for any major upfront investment.
– Power Purchase Agreement (PPA) – A long-term contract to purchase the electricity generated by the solar power system, usually 10-15 years. The rate is lower than your utility but may be slightly higher than the CAPEX model.
– Operation, maintenance and performance – All responsibilities for operating, maintaining and ensuring optimal performance of the solar system lies with the service provider.
– Scalability – Businesses can easily scale solar capacity up or down through their PPA.
The OPEX model offers an accessible path to solar energy for businesses unwilling or unable to make major upfront investments. While you don’t own the system, it provides cost savings with minimal hassle.
The OPEX/PPA/RESCO model offers several key advantages that make it an attractive option for many businesses looking to adopt solar power:
No Upfront Costs
One of the biggest pros of the OPEX model is that there are zero upfront costs for the business owner. The RESCO handles the entire initial investment for purchasing and installing the solar panels and equipment. This allows businesses to avoid the huge capital expenditure required to buy their own solar power system. The business simply pays for the electricity generated by the system on a per unit basis. This predictable electricity bill each month is the only cost.
Low Maintenance
With an OPEX contract, the RESCO is responsible for all maintenance and repairs related to the solar power system. So the panels, inverters, wiring etc. are all looked after by the RESCO. The business owner does not have to worry about system upkeep or finding technicians to service the equipment as needed. This makes it a hassle-free arrangement.
Easy to Scale Over Time
A major advantage of the OPEX model is the flexibility it offers in system sizing. If the business grows and energy needs increase, it’s easy to adjust the PPA and add more solar panels to scale up power generation. There’s no need for the business to make additional capital investments to expand the system. The RESCO handles upgrading the equipment as required. This scalability makes it easy to right-size the solar system for current energy needs.
Choosing the Right Solar Business Model
When selecting a solar business model, it’s important to reflect on your budget constraints, risk tolerance, and long-term goals.
The CAPEX model may be the best fit if you want more control over your energy source along with tax deductions and incentives. Since you own the system under CAPEX, you benefit directly from government solar subsidies and accelerated depreciation. This allows you to maximize savings over the lifespan of the panels. Just keep in mind that the upfront costs will be higher and you take on more maintenance responsibility.
For businesses that want to avoid high initial investments, the OPEX model is very appealing. The third party finance provider shoulders the upfront panel and installation costs, so you can start benefiting from solar right away. However, electricity rates are slightly higher than the CAPEX model over the long run. And maintenance becomes the responsibility of the RESCO, not you.
Ultimately, choosing between CAPEX and OPEX depends on your budget, tolerance for risk, and goals for long-term savings or low initial outlay. Analyze your specific business needs to determine if the benefits of control and tax incentives outweigh the convenience and low startup costs. With the right solar model powering your company, you’ll be well on your way to joining India’s renewable energy revolution!
What is the basic business model of a renewable energy power plant or project? The key elements of business models for electricity generators from renewable sources are the revenue streams, cost structure and the way it is financed. With the exception of biomass and biofuels, working capital considerations are not as important (once in operation) due to low fuel and maintenance requirements.
Investing in a Sustainable Future
Revenue Model
The most significant revenue stream comes from selling electricity to the grid, either at a fixed price (guaranteed feed-in tariff) or a market price. If the installation is not grid-connected, the savings from not having to purchase electricity from other sources improve net income in the same way.
The project may also be able to generate and sell renewable energy certificates or carbon emission reduction certificates, depending on the country.
Operating Model
There are few operational expenses, as maintenance fees tend to be low, although some technologies may require major maintenance half way through the lifetime of the plant - for instance inverters in solar plants may need to be replaced well before the modules.
Tax only needs to be paid after the investment has been fully depreciated.
Investment Model
Renewable energy generators require an up-front investment, which may be spread over the duration of the construction. Once operating, no further injections of capital are required unless a major incidence happens, which can be avoided if cash is kept in a major incidence account, funded from current cash flows.
Financing Structures
Here are some of the more common structures of financing renewable energy project. They vary in the type of participants, source of financing and allocation of benefits.
Corporate Financing
One corporation develops the project and finances all costs. There are no other investors or lenders involved. The project may be set up as a subsidiary of the corporate parent. However, with 100% ownership, the subsidiary would have to be consolidated into the parent's financial accounts.
Naturally, the corporation reaps all the benefits of the project.
The corporate parent must have sufficient capacity for tax credits and benefits to be of use.
In the renewable energy sector, this is structure is rare and only used by utility companies themselves.
Sale before Construction
The developer acquires lease and land rights, permits, interconnection agreements, power purchase agreements and any renewable certificates or feed-in-tariffs.
The developer sells the developed project to a strategic investor and receives a development fee from the investor.
The strategic investor (possibly a utility company) constructs the project on its balance sheet or arranges bridge finance for the construction. The strategic investor owns and operates the plant. The developer's risk is limited to the development capital.
Sale after Construction
The developer seeks bridge financing from lenders:
Construction Loan: Bank is repaid in full at completion of construction. Alternatively, bridge is converted into long-term loan.
Cash Equity Bridge: Bank is repaid at completion of construction with funds from sponsor. Developer may provide limited guarantee for cash equity.
Tax Equity Bridge: Bank is repaid at completion of construction with funds from tax investor, who will only come in once the plant produces tax credits.
Investor Ownership Flip
The investor contributes almost all of the equity and receives a pro-rata percentage of the cash and tax benefits prior to a flip in allocation.
At a given level of IRR (internal rate of return), the ownership flips back to the developer, after which most of the cash and tax benefits are allocated to the developer.
Only the production tax credits will continue to go to the tax investor even after the "flip".
If the investor is a tax investor rather than a strategic investor, the pre-flip allocation may not be pro-rata, and all tax benefits may go to the investor instead.
Leveraged Ownership Flip and Pay-As-You-Go ("PAYGO")
This is the most common project finance structure.
The tax investor makes contributions before production begins, though a portion may be deferred until the project receives production tax credits, which are initially allocated to the tax investor, though a high percentage is paid to the developer as an equity contribution. This serves as a claw-back should the project not perform.
The leverage is at project level with long-term debt of up to 18 years, based on the PPA (Power Purchase Agreement).
This structure also includes a return-based flip in the allocations.
As the term for the production tax credits is usually, an additional loan may be secured against those flows.
Back Leveraged Structure
Similar to the Investor-Ownerhip-Flip structure. However, the developer is leveraging its equity stake in the project using debt financing.
The tax investor commits equity upfront.
Pre-Flip: Initially, 100% of cash goes to the developer until return of investment (similar to a development fee). Then 100% goes to the investor.
Post-Flip: After the investor's pre-agreed IRR (typically 7% - 10% depending on project risks) is reached ownership and cash flow allocations go back to the developer, including most of the tax benefits.
Leveraged Lease
Construction is funded by sponsor equity and a construction loan. Once constructed, the sponsor sells the project to the investors that have formed a trust and immediately leases it back.
The develpoper repays the construction loan from the sale proceeds. The trust is financed with cash equity and a non-recourse term debt. Lease payments are likely to be assigned to a lender. For tax purposes, a minimum of 20% equity is usually required.
Leasing generates a "time value of money" cost saving achieved by deferring tax payments. It also improves cash flow.
If set up as Operating Lease, the lease may only be for 5 years with the option to re-lease.
Homeowner Model
When homeowners invest in renewable energy generators, they will own 100%. However, quite frequently, they can get bank finance, in some cases up to 100% of the capital costs!
Depending on the jurisdiction, homeowners may have to set up a company to run the generator, in whcih case they will also be able to profit from tax benefits.
However, unless they can offset the investment against profits elsewhere, the overall tax benefits are not significant. The lack of tax benefits, however, is often compensated for by higher feed-in tariffs for small installations..
The Optimum Financing Structure
That very much depends on the project itself as well as the participants. As with other infrastructure projects, capital intensive energy projects are often financed as stand-alone entities (Project Finance) rather than as part of a corporate balance sheet (Corporate Finance). The main advantages of project finance are:
- Non-recourse/limited recourse financing: There is no or only limited recourse to the project sponsor's assets for the liabilities of the project. Thus, the project preserves the sponsor's debt capacity.. Also, lenders will be more keen to participate in a workout.
- Risk Sharing: By setting up a separate legal entity, the project risk is isloated and can be allocated to the parties that can best control, understand and mitigate the risks involved. Consequently, incentives for all involved are optimized. This includes political or country risk.
- Favourable Tax Treatment: Project Finance structures allow tax benefits to be allocated to entities that can make use of them.
- Improved Financing Terms: The project may obtain more favourable finnacing term than it would based on the sponsor's credit profile alone. This way projects can be carried out that would be too big for one sponsor.
However, all of these benefits come at a high transaction cost, higher interest rates and insurance coverage.
How to choose the Financing Structure?
The developer who initiates the project decides which finnancing structure best meets their needs for a project based on multiple considerations.
| Consideration / Motivation | Context | Most suitable structure |
|---|---|---|
| Project Size | If the project's value is less than $50m, the transaction costs of Project Finance will outweigh the benefits. | Corporate |
| Developer can use tax benefits | If the developer wants to use tax benefits, the project needs to be on its balance sheet. However, often, developers are much smaller than the projects they develop and have no capacity to use all the tax benefits. | Corporate |
| Developer can fund project costs | If the developer can fund project costs | Corporate PAYGO |
| Low Project IRR | If the project's projected internal rate of return (IRR) is low, increasing debt levels will help increase the equity holder's rate of return. | Leveraged Structure |
| Developer wants early cash distribution | Due to the large capital expenditure there are no early cash distributions available if developed on own balance sheet. The developer either needs to sell early, or device a structure wehereby the developer receives a large proportion of cash. | Project Sale Back-leveraged PAYGO |
| Re-financing | If the projeect already exists, but just needs re-financing, possibly after construction, options include a pay-as-you-go structure or leasing. | PAYGO Leveraged Lease |
Impact of financing structure on returns and the cost of energy
The investor's internal return and the plant's levelised cost of energy vary with the choice of financial structure.
We have calculated the weighted average cost of capital, investor's internal rate of return and the levelised cost of energy for investment in a 1MW solar park for different financing structures.
The levered structure yields the highest return and lowest cost of ownership because of the lower cost of debt and the tax shield provided by the debt. Also, the debt lowers the average cost of capital, though increases the expected return for the investor.
The cost of ownership is highest in the "sales after construction" scenario, as the interest for financing the construction before the sale has been added to the capital cost of the whole plant.
With India’s ambitious solar energy goals, businesses have an incredible opportunity to invest in a more sustainable future. Going solar doesn’t just make economic sense; it benefits the environment and allows companies to demonstrate social responsibility.
Going solar makes sense financially and ethically. With two attractive models to choose from, every forward-thinking business can find a way to profit from the power of the sun while advancing India’s renewable energy revolution. Leading this sustainability drive will enable the country to shine bright as a beacon of climate action and progressive vision.
