How development corporations can utilize off-balance sheet financing Featured

3:44pm EDT September 1, 2012
How development corporations can utilize off-balance sheet financing

To finance purchases, a company usually has a number of options, including equity financing from venture capitalists, mezzanine financing, a line of credit or growth capital. But there is also an interesting option called off-balance sheet financing, or project financing, which can help fund large projects and is particularly well suited to the purchase of clean technologies, especially solar development.

“Off-balance sheet financing has been around for a long time — nearly 100 years — and it’s available to many development corporations or manufacturers,” says Scott Reising, senior vice president of the Energy and Infrastructure Group for Bridge Bank.

“But it now is being applied to clean technology companies — those that manufacture renewable sources of power and the infrastructure to support it — because they often struggle to get financing. This is a unique option to finance the purchase and sale of their products,” he says.

Smart Business spoke with Reising about the off-balance sheet financing option and how it can allow companies to fund noncore projects, including those related to clean energy technologies.

What is off-balance sheet financing?

Off-balance sheet financing could be considered a single loan to a specially designed company that has a single purpose. A separate entity or ‘company’ is established on paper that will channel the purchase of a large amount of equipment from a corporate manufacturer to a purchaser. A contractual arrangement is established that allows the purchaser to pay for the product over time to the special, new project company that has been created in the transaction. Oftentimes, through this model, installation is also covered and a fee is assessed for the risk that’s being taken.

This financing structure allows the manufacturer to complete the sale and get paid in full, while the purchasing company receives the goods up front and pays for them over time. As a bonus, the return on investment realized by the purchaser often can offset much of the payment made for the product. This is especially true when financing clean technologies, as the energy savings can be equal to the payments.

What are the advantages of off-balance sheet financing?

The debt being provided is less expensive than the cost of equity. Also, debt terms are amortized over time to match the asset life of the product purchased. Additionally, in project financing, typically there are higher levels of debt, often between 60 and 70 percent. A large portion of the debt is financed over a longer period of time, so it dramatically lowers the upfront cost.

Why might this option be more attractive than other types of financing?

A big corporation’s function is to develop its core business, not to spend time on ancillary things. Even though large corporations can access capital through other means, off-balance sheet financing has its own accounting code as opposed to being in the core business. If you can set up the means through a new project company to finance and manage the maintenance and installation of a clean technology project you’re better off.

On the seller side, the issue is scalability. If a manufacturer of clean technology has to create its own loan to fund a purchase it will likely have to lend funds for each sale, which is unsustainable.

What does a lender need to evaluate a project for this type of financing?

Lenders typically need to quote all information related to the product. They need to understand the technology and would want to have the company get them comfortable from an engineering point of view. A bank will use an outside consultant to verify what the company has stated to be the specifications and performance characteristics. Often a company has its own data to back up its product claims because it wants to prove its technology works and has worked for some time.

Banks also will want to look at the sale and purchase contracts that have been established for the equipment. A bank will need information on the purchaser including its audited financials, creditworthiness, its ability to make payments and its business plan.

How do banks view the creditworthiness of clean technology?

There are three reasons clean technology is being utilized right now. The first is corporate social responsibility, which allows companies to publicize that they are using environmentally friendly and sustainable energy.

Second, renewable products are very cost competitive in terms of present value.

Third, a company stepping into clean technology is making a statement to its customers and competitors alike that it’s going to be there for a long time. To a bank, the perception of longevity increases its willingness to lend.

What should a clean technology company look for in a potential lender?

A clean technology company should look for a lender with a strong understanding of the company’s needs, its products and how it works. It also should seek a bank that has a willingness to work on scalability.

The seller wants to develop a smooth, long-term relationship with its bank in order to provide financing to its buyers, so it should work with a bank that has done this before. Additionally, it should look for flexibility in the financing structure because each buyer has different credit backgrounds, contract needs and risk/reward expectations.

The company also needs the right size bank to handle the volume it wants. If the project size is small, a large national bank might not deal with it. Also, ask if the bank’s credit committee has approved this type of asset in this industry in the recent past and how frequently.

Scott Reising is senior vice president of the Energy and Infrastructure Group for Bridge Bank. Reach him at (408) 556-6508 or scott.reising@bridgebank.com.

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