Project developers are always confronted with the decision of how to pay for their project. Their capital costs run the gamut from system hardware costs (module/inverter/structural and electrical) to permit, inspection, and interconnection costs. Problems from supply chain issues and rising interest rates are making financing arrangements more difficult. Developers may have to dig deep to consider the options they have to get their project over the finish line.
This article outlines two possibilities developers may consider when financing their project: a development services agreement (DSA) or development capital. What are they and how are they different? Most importantly, why would a developer choose one option over the other?
Development Services Agreement
A DSA is an agreement between an investor and a developer looking to install a renewable energy system such as a utility scale solar or a battery energy storage project. The developer has experience building renewable energy projects but may not have the financial wherewithal to pay exorbitant project costs. Before committing to a DSA, the developer must consider two critical factors: (1) the project risk and reward; and (2) project ownership. Let's consider each of these in turn.
Risk and Reward
Several months ago, we wrote about the important factors in starting a clean energy business. One of them was personal temperament for risk. That same reasoning applies here. Presumably, the developer will understand the site control issues of a project, the right to use the property to develop/construct/operate it for its useful life. But how much risk does the developer want to take on? Is it worth it to ride out the project, with its risk, in the hope for an upside and large payout? Or is the developer decidedly risk averse and would rather have someone else bear that risk in exchange for a more predictable income stream?
In addition to the risk-reward tradeoff, a developer must decide whether they are comfortable handing over the project ownership to a third party. With a DSA, an investor owns the project, not the developer. The developer has the skills to do the project, but the investor has money and wants to own the project. The developer brings the project to the investor, the parties sign a DSA, and then the investor ultimately acquires it.
Once signed, the investor considers the developer an employee of sorts and that individual is paid a salary, with additional compensation based on project milestones. If the project has a huge payout, however, it is the investor who ultimately benefits. The DSA also has other details that need ironing out such as local permitting and standard of care. But the basics include transfer of ownership and risk to a third party in exchange for a predictable payment.
Development Capital, on the other hand, is a loan which allows a developer to grow and expand. Choosing development capital allows a company to focus on long-term growth as opposed to a quick investment return. Most importantly, development capital funds a developer's project and its business without any ownership changes.
Since the developer retains control of the business, that individual assumes all the project risk. If there is a large payout (i.e., favorable offtake agreement), the developer keeps it because they assumed the risk and were willing to ride out the project.
As a summary, development capital is better suited for project developers who have an appetite for risk (which many in the clean energy industry possess), have a penchant for riding out the development cycle (i.e., long interconnection queues), and ultimately want to own the project and its future. Additionally, choosing non-dilutive development capital allows developers to keep their equity.
The table below illustrates the factors involved in this important decision.
Leyline Renewable Capital specializes in development capital as a project financing option. As a team of former developers, we have a thorough understanding of that world. If you want to explore development capital for your project, please contact us at https://leylinecapital.com/home/contact. We look forward to helping you cross the finish line!