Basics of Energy Project Financing 141For energy equipment, leases have the added benefit of offering
100% financing; that is, your company does not have to make a substan-
tial down payment and can thus conserve its cash for daily operations.
There are numerous types of leases. Operating, capital, and municipal
leases deserve special attention.
A capital lease is one which appears on the balance sheet of the les-
see (the borrower) as a debt in much the same way as a commercial bank
loan. A typical commercial or industrial company, such as a steel manu-
facturer, is a good candidate for lease financing. The rates for such leases
are usually 1%-5% above prime.
Most leased energy equipment uses the capital lease structure,
which may include any of the following: transfer of ownership of equip-
ment at the end of the lease, a dollar buyout clause at the end of the lease,
a lease term equaling 75% or more of the economic life of the equipment,
the net present value of the lease payments equaling or being greater
than 90% of the value of equipment.
An operating lease is designed to fulfill certain requirements of the
Financial Accounting Standards Board (FASB) and the Internal Revenue
Service. A well-structured operating lease does not have to be reported
on your company’s balance sheet as debt. That is, it does not appear as
a liability like most bank loans or credit lines but is merely a regular
expense obligation on the income statement, such as office rent. Often-
times this can be very important for a company or institution that does
not want to affect its borrowing capacity or its cost of capital by adding
more debt to its financial structure.
Operating leases are difficult to structure for energy equipment be-
cause it is not easy to estimate the useful life and the fair market value
of the equipment several years after installation. What is the value of an
energy management system or compact fluorescent lights five years af-
ter they have been installed? There are stories of energy equipment leas-
es that were structured as operating leases but which, upon closer scru-
tiny by auditors, had to be converted to capital leases. This could cause
a substantial effect to a company’s financial structure, or worse, trigger
default clauses under bank credit lines that are vital to the company for
day-to-day business.
Another kind of lease is the municipal lease. Any entity that raises
revenue through taxation and qualifies according to the IRS as tax-ex-
empt (under Section 103(c) of the Internal Revenue Code of 1986) can
have access to a municipal lease. This form of lease is often used by state