Financing renewable energy projects: Raising equity

Updated April 2011

Renewable energy projects

The UK has great potential for renewable energy supply but there are various barriers to entry, including cost. Financing a renewable energy project will entail many of the same considerations as financing any other project, but the profile of a renewables project makes some structures more attractive than others.

Renewables projects are capital intensive and require up front cash injections, with revenues being generated much later from the fully constructed and commissioned site. The most common sources of finance are set out below, which are often combined:

• Cash – raising equity through cash reserves or raising new equity finance from potential investors
• Bank debt – on balance sheet and inevitably requiring security to be given to the lending bank over the entire group and potentially guarantees from individuals
• Joint ventures – using a partner with available sources, or one which is in a better position to raise finance, especially one with previous experience
• Limited recourse financing – on balance sheet again but where bank recourse is limited to the assets of the project itself and against future cashflows

The development will often take place in a specially formed project company. That project company will often look to leverage with bank funding to provide better returns and the developer will look to bridge the gap between construction cost and bank funding with equity. This note looks at some of the ways a developer can raise cash to fill this equity gap from potential investors, although it does not cover the different types of instrument which could be offered or the exit strategies which can be adopted. 

Background

The Department of Energy and Climate Change (DECC) policy focuses on four key areas:

• global climate change and energy
• UK energy supply
• supporting consumers and
• a low-carbon UK

EU targets in the Renewable Energy Directive 2009 include that 20% of the EU's overall energy consumption (electricity, heat and transport fuels) must come from renewable sources by 2020. The 20% EU target is broken down into individual national targets. The UK must ensure that 15% of its overall energy (not just electricity) comes from renewable sources by 2020.

The UK has adopted certain measures to promote renewables in the UK, the main one being the Renewables Obligation (RO), requiring all electricity suppliers licensed under the Electricity Act 1989 to produce evidence to Ofgem that they have supplied customers in Great Britain with a certain amount of electricity generated from renewable sources. The amount of renewable electricity increases from year to year.

For small scale production of electricity, Feed in Tariffs (FITs) were introduced in April 2010 for installations with generating capacity up to a maximum of 5 MW (albeit subject to review for larger solar projects above 50kw). Following the coalition government’s comprehensive spending review in 2010, incentives for small scale production of heat using renewable sources (the Renewable Heat Incentive) is now moved back and to be implemented in 2011/2012, but not on the basis of the previous Labour Government’s model.

Key questions

Key questions to ask when considering how to raise equity include:

• How much am I looking to raise?
• Who is my target investor?
• Will my target investor be looking for income/capital return?
• Will my target investor be looking for a tax efficient product?
• When will my target investor want to exit?

Regulatory considerations

There is a complex regulatory framework governing offers for financial products and services in the UK. Failure to comply can result in both criminal and civil sanctions as well as reputational damage. The overarching principle is that all information about financial products and services must be 'clear, fair and not misleading'. Therefore whether a developer is looking to find investment for a project, or series of projects, by way of shares, debt securities (such as bond issues or loan notes) or through a fund, raising that finance needs careful thought. Some considerations are set out below.

Prospectus Rules: a full prospectus is required for an offer of transferable securities to the public. Exemptions do apply, for example when the maximum you are looking to raise is €2.5 million in any 12 month period, or the minimum subscription by any single investor is the equivalent of €50,000. It is possible to offer non transferable securities, however this can be less attractive to an investor. A full prospectus is a lengthy and costly document which needs to comply with the Prospectus Rules and therefore is usually used only to raise substantial funds from the general public for a longer term development strategy or a large scale single project.

Financial Promotion Restriction: you may not, in the course of business, communicate an invitation or an inducement to engage in investment activity unless you are a person authorised to undertake regulated activities by the Financial Services Authority (FSA), or the communication has been approved by such an authorised person. Even if you avoid a full prospectus (for example a smaller capital raise), you cannot send an offer document to just anyone if you are not FSA authorised. Exemptions include communications to high net worth individuals and sophisticated investors who meet the strict criteria set out in the Financial Promotion Order. Therefore a developer can still raise funds from the general public if structured correctly, or else make offers only to eligible investors.

Scheme Promotion Restriction: often a “fund” (whether intentionally or not) is a collective investment scheme (CIS). A CIS is an arrangement that enables a number of investors to pool their assets, which are managed by or on behalf of the operator of the scheme (the developer), with a view to participants sharing profit or income from the purchase, holding, management or disposal of the assets or sums paid out of such profits or income. The essence of a CIS is shared profit or income through collective investment, where the participants of the scheme do not have any day to day control over the management of the property. This structure is often very attractive to developers however, establishment, operation and management of a CIS must be undertaken by a duly FSA authorised person and the scheme may not be marketed to the general public unless the fund is an authorised CIS (which are expensive and have restrictions on investments). An unauthorised person is bound by the Financial Promotion Restriction (see above). An authorised person is bound by the Scheme Promotion Restriction which prohibits them from promoting (themselves or where they have approved on behalf of an unauthorised person) unregulated CIS's in the UK except in certain circumstances. Traditionally, unregulated schemes have been higher risk than regulated schemes and the exemptions are intended to ensure that the class of people who receive promotions for unregulated schemes is restricted, so far as possible, to those for whom participation is likely to be suitable. CIS's tend to be part of tax efficient schemes. Due to the costs of involving FSA authorised persons, costs can be high both initially and ongoing, however on a sufficient scale these structures can be very attractive to investors.

Tax considerations

It is possible to raise equity and/or invest that new equity in an underlying project company in a way that is tax efficient and therefore attracts investors who are looking for a tax led product or investors who are restricted from investing directly in private companies. Some examples are set out below. Importantly, from 6 April 2012 FITs businesses will no longer be eligible businesses for investments under the Enterprise Investment Scheme or Venture Capital Trusts. However, the schemes will remain open to other non FITs renewables projects which meet the eligibility criteria.

Enterprise Investment Scheme (EIS): EIS provides eligible investors with certain tax reliefs where they invest in shares in an EIS qualifying company. Potential tax reliefs include income, capital gains exemption, losses on disposal of EIS qualifying shares and capital gains deferral. There are numerous criteria for eligibility attaching to the investors, the shares and the underlying company.

There are two basic structures; direct investment into the underlying project company, or investment into an EIS Fund which then invests in the underlying project company or series of project companies. The maximum amount a single company can raise in any 12 month period under the EIS is £2 million which can be too little for renewables projects and therefore an alternative is an EIS Fund. EIS Funds can be either HMRC approved or unapproved.

• Approved – must make four investments within one year of the closing date of the fundraising. The advantage is that income tax relief is available immediately to investors from the date the fundraising closes.
• Unapproved – no limit on the number of investments or timeline. The disadvantage is that investors only get income tax relief from the date of the underlying investment by the EIS Fund.

An EIS Fund may be structured through some form of legal entity, for example a limited company but this is tax inefficient. HMRC has indicated that EIS Funds structured as a partnership, including a Limited Partnership, will result in income tax relief being lost. This is therefore not an appropriate vehicle. Usually the EIS Fund will have no legal form but instead will operate as a bank account with various agreements in place as to how the cash is to be invested. The investment manager will hold the shares in the EIS Companies as nominee for investors, as well as making decisions as to how cash is invested. This is effectively a discretionary management service (as opposed to a CIS) requiring FSA authorisation.

Venture Capital Trusts (VCT): VCTs are more likely to be target investors as opposed to the vehicle to raise equity by the developer. This is because a VCT is a company which is listed on the London Stock Exchange, run by a professional investment fund manager and investing in a range of small private companies.

English Limited Partnerships (LP): LPs are registered partnerships which (unlike a traditional partnership) provide limited liability for non-managing partners (limited partners). Partners with managerial responsibility (general partners) retain full and unlimited liability. To retain limited liability the limited partners must not have any control of the day to day running on the LP. LPs are attractive as they are tax transparent. LPs tend to be CISs and like all CISs can be expensive to set up and to maintain (needing the input of FSA authorised persons on a continuing basis) but can be very attractive to investors. Pension funds can also be introduced through a sister unit trust or exempt property unit trust where the trust manager then becomes a limited partner in the LP.

Contributor: Alex Watson

This publication is intended for general guidance and represents our understanding of the relevant law and practice as at April 2011. Specific advice should be sought for specific cases; we cannot be held responsible for any action (or decision not to take action) made in reliance upon the content of this publication.

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