In our line of work, we come across many businesses who have identified energy efficiency projects that stack up well when their payback periods are analysed and yet they are hesitant to turn these opportunities into a reality.
Some key hurdles we have observed include not owning their premises, a lack of time, perceived risk or because energy costs up until recently only formed a minor part of their overall operating costs. The biggest and recurring barrier, however, is typically cashflow constraints. A lack of immediate funds understandably leads to uncertainty when it comes to investing in projects that aren’t directly aligned to core business, even when the savings could be profound.
So, what are the options?
If an energy efficiency project or, for that matter, any resource efficiency project, cannot be self-funded, with tax deductions made via standard asset depreciation, there are many options available. These include:
1. Sourcing a loan
Getting a loaning alleviates the problem of not having your own upfront capital whilst still allowing the business to own the assets. As a business, you are taking on any elements of technical risk that may be involved. Of course, repayments need to be paid to a third party and the project will generally cost more in the long run but may help with cashflow or allow you to invest in several projects concurrently.
- Commercial loan – the loan may be secured against an asset (e.g. your business or smaller item such as a car or equipment item) or unsecured meaning that the lender cannot take possession of your asset if you default. An unsecured loan will typically have a higher interest rate. For this option to be viable the financial savings from the project (e.g. reduction in energy costs) would cover the repayments including interest and principal.
- Green business loan – Many financial institutions offer green loans or bonds. Interest rates are often lower than standard commercial loan rates.
- The Clean Energy Finance Corporation (CEFC) is a government backed financing body and provides competitive rates. While the minimum loan amount is $25 million the CEFC also works with various co-financing institutions (NAB, Commonwealth, Westpac etc) to offer smaller loans ranging between around $10,000 to $5 million. The projects have to meet the criteria of this fund to be approved.
- The Queensland Rural Adjustment Authority (QRAA) also provides Sustainability Loans for primary producers in Queensland to help improve productivity and profitability.
- Chattel mortgage – The financier advances funds to the business which takes ownership of the ‘chattel’ i.e. a moveable item such as a vehicle. Security on the loan is provided by the ‘chattel’. Once all the repayments have been made the financier removes their security interest giving the business clear title.
2. Leasing the equipment
Leasing allows businesses to avoid upfront costs meaning the project can be managed within the business’s operational budget.
- Capital lease (also known as asset or finance lease) – The equipment is the property of the lender but reverts to the business at end of lease, possibly after payment of a residual. Repayments are usually fixed for the term of the lease. This asset appears on the company balance sheet. Lease payments are fully tax deductible as well as depreciation of the equipment.
- Operating or rental lease – The equipment e.g. solar panels or lights, remains the property of the lender. At the end of the contract, you may have the option to re-finance, buy outright or upgrade. The asset is ‘off the balance sheet’ which can provide tax related or other accounting benefits. The lease payments are fully tax deductible. This may tie you to the energy service provider and potentially to set energy rates for the period of the lease.
- Solar leasing – A provider pays for the installation of the system and the company purchases the power that it generates. Again, there are no upfront costs for the installation and maintenance is the responsibility of the provider. The repayments are fixed regardless of how much electricity is consumed. So, if your company closes for several weeks over a holiday period you are still required to make the same payments. Solar leasing contracts generally last 5-10 years and so you could be locked into a contract with repayments that make the entire system more expensive than paying upfront. It is important to check contract exit fees. It is likely that you will be unable to change service providers for the duration so will have little buying power to negotiate better rates. Similarly, if production changes dramatically during this period either up or down there may be limited scope to negotiate a change in the contract. However, it can be a cheaper and worthwhile option than not having solar at all.
3. On bill financing
On-bill financing use regular utility bills as a way for a business to repay upfront capital costs in an energy project. They are often used for solar PV installations. Agreements are typically 5-7 years. The interest component of repayments is tax deductible and repayment liability are on the balance sheet. This can be a convenient finance method however, once again you are locked into a contract with that service provider for the duration of the contract with potentially limited scope to negotiate rates.
These agreements are essentially a full-service outsourcing arrangement where the provider owns the energy efficient equipment. Once a project is operational the business pays fees to cover operational and maintenance costs, including energy costs, and to repay the capital and installation costs. This is a turn-key solution where the monthly fee is calculated to be less than the existing costs. There can be a reduced risk to the company as the onus to produce a profit is on the provider through delivering the energy service more efficiently.
- Energy Services Agreements – These are performance-based contracts where a service provider (i.e. provides energy related service e.g. solar generated electricity, steam, lighting or air conditioning) agrees to finance and deploy energy projects or upgrades for a business without any upfront capital expenditures.
- Power Purchase Agreement (Solar) – A solar provider pays for the installation of the solar system and the business purchases the power that it generates. The provider retains ownership and responsibility for the system as well as any maintenance costs. There are no up-front costs for system installation and responsibility for maintaining the system lies with the provider. Monthly payments are made per unit of electricity delivered and electricity is charged at agreed prices through the duration of the contract, potentially providing protection from possible price rises. Prices are lower than the traditional energy provider.
Whatever finance option you are considering, it is important to talk with your accountant and operations manager and use the usual investment analysis tools to work out what is the best option.