102 Energy Project Financing: Resources and Strategies for Success
though the ESCO is the borrower, the project must perform in order for
the loan to be paid back on schedule.
The best way for the ESCO and lender to analyze a project is to view
it as a stand-alone company. This “company” has revenues, expenses, as-
sets and debt which will vary over time. The revenues are the estimated
share of savings payments your organization agrees to make to the ESCO
or to the single-purpose entity. The expenses may include equipment
maintenance, measurement and verification (“M&V”), or even the cost of
raw materials to produce sold “goods,” such as chilled water.
Lenders will be most interested in the debt service coverage analy-
sis. How do the net revenues (net income after expenses) compare to the
project loan payments? If the net revenues are $25,000 per month and
the lease payments are $20,000 per month, the Debt Service Coverage
Ratio is 1.25. Most lenders prefer debt service ratios above 1.10 in order
to provide some protection against fluctuations in project revenues and
expenses.
If the debt service coverage ratio is too low for your project, you
may want to run some alternative scenarios. First, try to extend the
term of the loan. This will have the effect of lowering the payment per
month and increasing the coverage ratio. Second, if the expenses of the
project are high, relative to other projects, you may want to consider
restructuring the project. Eliminating a costly piece of equipment with
high maintenance expenses may well lower the simple payback of the
project and increase the chances of the project’s overall success. A third
option is for the ESCO to use its own cash to pay for a small portion of
the project, thus decreasing the loan amount.
In terms of a presentation to your organization’s finance team,
any project needs to be compared to other projects which are vying for
management’s attention. The tools of comparison are Net Present Value
(NPV) and Internal Rate of Return (IRR). The NPV is the value in cur-
rent dollars of the positive and negative cash flows over time related to
the project. In order to perform this calculation, an interest rate must be
selected; usually it is equivalent to the opportunity cost of your com-
pany. This cost is the rate of return that the company receives on aver-
age in most of its relatively safe projects. The IRR is the rate at which
the NPV is zero. The project has a high likelihood of being accepted by
your management if its NPV or IRR is higher than other projects. For
financing success stories, see Chapter 2.