Direct Investment in Renewable Energy for Family Offices

Direct Investment in Renewable Energy for Family Offices

Investors are allocating a greater share of capital to socially responsible and environmental, social and governance (ESG) conscious strategies. A January 2018 Harvard Business Review article noted that at the beginning of 2018, more than $11.6 trillion were invested in ESG investment strategies. That equates to $1 of every $4 invested in the United States.

Much of this capital, however, may not fairly reflect the true goals and values of the families and individuals who own it because few companies evaluate success based on the “triple bottom line” of social, environmental and financial results. As a result, most ESG funds reflect relative rather than absolute social principles. In addition, the qualities of an investment that create social benefit are difficult and expensive to measure.

This is not the case for direct investments, which can easily be evaluated for social impact. For example, an investment in a biomass plant that turns farm waste to energy will create a number of well-paying jobs, produce renewable fuel and electricity, and avoid the greenhouse gasses that would have resulted from fossil energy. Each of these outcomes can be measured and compared to expected results, providing investors with known social and environmental results.

In addition to alignment with investors’ social goals and values, direct investments in renewable and alternative energy projects generate appealing risk-adjusted financial returns, particularly in the commercial and industrial segment. The table below shows sample returns from various direct investments in distributed alternative energy resource direct investment structures.

Overview – Cogeneration involves powering a primary engine that drives an electric generator and recycling the primary engine heat to manage the thermal load of the facility. The primary engine is typically run on natural gas, but biofuel may also be used. Because cogeneration systems utilize efficient fuel, recycle excess heat and do not suffer meaningful transmission loss, they are 75% to 85% more efficient than utility-provided electricity. This efficiency translates into cost savings and environmental sustainability.

In addition to their high efficiency, cogeneration systems benefit from the use of well-established technology. Equipment is typically designed by and acquired from large manufacturing companies that offer extensive warranties. System maintenance can be sources from a number of local providers and replacement parts, should they become necessary, are readily available. Power generated from distributed systems also offer greater consistency as they are unaffected by grid restrictions and outages.

Cash Flows – Cash flows from a cogeneration system is generally determined pursuant to an energy services agreement (ESA) based on the availability (up-time) of the system rather than the amount of power generated or consumed. This arrangement assures the system owner will receive consistent payments regardless of the off-taker’s energy consumption, assuming the system operates as expected. Further, system efficiency ensures the counterparty has sufficient cash flow from energy cost savings to cover scheduled payments to system owner.

Investment structures – Potential users of alternative energy are often unable to capitalize the upfront costs of a system. They are, however, interested in the cost savings, environmental benefits and superior reliability these systems offer. This need provides an opportunity for socially responsible and ESG investors to achieve excess risk-adjusted returns.

Investment structures for cogeneration systems available to family offices primarily include first-lien loans and capital leases. A capital lease typically calls for periodic (monthly or quarterly) fixed payments that fully amortizes the investment plus interest over a pre-determined term (typically 7-10 years). A first lien loan similarly calls for periodic payments, but may offer greater flexibility to the parties in repayments. In both cases, the offtaker is considered the owner for tax purposes. As such, they receive the tax depreciation and any available credits.

Management – A cogeneration system requires minimal maintenance, but some operating oversight is necessary. This responsibility is typically borne by the system developer, who manages a maintenance contractor and maintains proper insurance. In addition, the developer monitors the operation and uptime of the system, collects payments from the offtaker, and pays vendors, contractors and investors. The developer may collect a modest management fee for these services.

Overview – Biomass plants convert carbon-based waste to liquid and gaseous fuel and other valuable byproducts. A digester separates liquid and gaseous fuels. Typically the gaseous fuel is used to power a turbine that drives and electric generator. The electricity, liquid fuel and any byproducts are then sold. Examples of waste-to-energy feedstocks include wood and paper waste, animal and food waste, commercial and residential trash and plastics. Byproducts may include fertilizer, metallurgic coke and potable water, among others.

Biomass plants have greater social impact than most other types of renewable energy. From an environmental standpoint, biomass plants generate both renewable electricity and zero-carbon liquid fuel, they also often remove potentially harmful matter from the environment, such as animal waste and plastics. In addition, trash biomass plants divert material that might otherwise end up in a landfill. Finally, biomass plant development creates not only construction jobs, but long-term operating jobs as well.

Windmill Capital Management works with developers that utilize technology, often patented and proprietary, to extract the most energy possible from the target feedstock and are committed to zero harmful byproducts. We work with developers of commercial-scale projects with a cost between $5 million to $25 million (50 tons per day to 250 tons per day of feedstock). The exact combination and relative quantity of outputs depends on the type and composition of feedstock.

In order to ensure reliable feedstock supply, biomass plants are often co-located at facilities that are producing the feedstock. Such locations may include farms, food processing plants, and waste disposal transfer stations or landfills. Co-location takes advantage of shared resources, primarily land, and reduces transfer costs.

Cash Flows – Biomass plants generate cash flow from the sale of electricity, liquid fuel and byproducts. Each output typically requires a separate contract, or offtake agreement, to define the terms of sale. In addition, a biomass plant requires a small staff to manage and operate. Accordingly, the developer may elect to sell a project outright rather than operate it in the long term. As with cogeneration maintenance contractors, there are a number of independent third parties that staff and manage the operation of biomass plants. In addition, the co-location party is likely to prefer an ongoing interest in the plant. This can be good for passive investors, as their expertise and interest in operating and maintaining the plant efficiently and in good order aligns with those of the passive investor.

Investment Structures – Investment structures for family offices in biomass plants include equity (preferred or common) and secured debt (first lien or mezzanine). Common equity returns may be as high as 30% with payback periods of less than four years. Such an investment may permit the managing equity owner to buy-out the family office after five or six years. Terms of preferred equity or secured debt can be customized by the family office and the manager.

Management – As previously noted, biomass plants are more management intensive than cogeneration plants. Biomass plant management includes day-to-day operations, including full-time employees, ongoing monitoring an analysis, periodic maintenance, collection of revenues and payment of expenses and investor returns. Therefore, a qualified management team, while essential to a successful investment, represents an additional cost. These costs, however, are factored into any returns analysis an investor would expect to receive.

Qualified Opportunity Zones
Much has been written about Qualified Opportunity Zones (QOZs) and QOZ funds and the purpose of this paper is not to recount the details and benefits of this tax-driven opportunity. We note, however, that many of the cogeneration and biomass projects that we see are coincidentally located in QOZs and therefore qualify for preferential tax treatment, including deferral of capital gains and long term basis step up. If your family office is analyzing QOZ investments, we believe it’s worthwhile to consider these projects in particular. While we would not suggest that a project investment is viable solely because of its location in a QOZ, we are able to work with QOZ investors to achieve higher investment returns with this tax structure.

Our Process
There are a handful of firms around the country that specialize in commercial renewable energy project finance. Some of those firms arrange both debt and equity investments. A few of those firms make those investments available directly to investors rather than through a fund.
Windmill Capital Management works with alternative energy developers around the country to source high-quality projects. We have developed an extensive network of experienced, capable firms that bring projects to us to help finance. Of those, we select only those projects that meet our strict underwriting criteria, which analyzes the quality of the development, counterparties, materials, inputs, expected returns and financial structure. Only then do we introduce these opportunities to potential investors.

For More Information
In our experience, the best way for potential investors to understand a cogeneration or biomass project is to read a project summary and review the associated financial projections. These examples will provide details that are too specific to be addressed here and also provide meaningful context to project costs and cash flows. We look forward to hearing from you.

The information contained in this post does not recommend the purchase or sale of any security nor is it an offer to sell or a solicitation of an offer to buy any security. Any such offer will only be made in compliance with applicable state and federal securities laws pursuant to an offering memorandum and related offering documents Prospective investors are encouraged to consult with their financial, tax, accounting or other advisors to determine whether an investment is suitable for them.

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