Solar Companies As Finance Companies: Asset-Backed Securities (ABS), Institutional Investors and Power Purchase Agreements (PPA)

In the solar energy industry, companies such as Sunrun Solar, Sunnova, and Tesla Energy have gained attention for their technological and environmental contributions. However, beneath the surface, solar companies function much like finance companies. Here’s why.

1. The Business Model: Solar-as-a-Service

At its core, residential solar is an expensive product. The average upfront cost of a solar installation is $20,000–$30,000, making it unaffordable for most households without financial assistance. To address this, companies introduced innovative financing models such as leases, Power Purchase Agreements (PPAs), and loans.

• Leases and PPAs: Homeowners pay a fixed or per-kWh amount, often lower than their utility rates. The solar company retains ownership of the system, ensuring a steady cash flow over 20–25 years.

• Loans: Homeowners finance the system purchase and claim associated tax credits, but monthly payments mimic traditional financial loans.

These models shift the industry’s focus from selling a product to managing long-term cash flow.

2. The Role of Tax Equity and Incentives

Federal and state incentives, such as the Investment Tax Credit (ITC) and Renewable Energy Certificates (RECs), are key drivers for solar financing. Tax equity investors — typically large banks or financial institutions — partner with solar companies to monetize these credits. They front capital in exchange for tax benefits and a share of the project’s revenue. This financial engineering aligns more with banking than traditional energy operations.

3. Solar Securitization: Turning Cash Flow into Capital

To scale operations, solar companies bundle customer contracts into financial instruments called asset-backed securities (ABS). These securities are sold to institutional investors, providing solar companies with immediate capital while diversifying their risk. Companies such as Mosaic, and Goodleap are some of the big companies financing the solar revolution.

For example, over $13 billion in solar ABS has been issued since 2013, primarily by leading companies like Sunrun and Tesla. These ABS transactions mirror mortgage-backed securities, relying on steady customer payments to generate returns for investors.

4. A Focus on Financial Metrics

Solar companies install solar projects for customers with great credit scores and own a home with certain income requirements for PPA and Lease approvals:

• Credit Scores (FICO): The average FICO score for solar customers is 730–770, ensuring reliable payment streams.

• Income Thresholds: Solar companies often set minimum income requirements for customers to ensure they can afford ongoing payments.

• Homeownership: PPAs and leases are typically offered to homeowners rather than renters, as homeowners are more likely to stay in one location for the duration of the agreement (10–25 years). Ownership ensures that the solar system is installed on a property where it will remain for the contract’s life.

PPA Deep Dive: Payments, ITC + State Incentives, and Cash Flows to Solar Developers and Tax Equity Investors

1. Customer Contracts and Initial Costs

When a homeowner signs a Power Purchase Agreement (PPA) or Lease with a residential solar developer (e.g., Sunrun), the following process unfolds:

• No Upfront Cost to the Customer: The solar developer covers the initial cost of equipment (solar panels, inverters, and optionally batteries).

• Funding Source: This upfront cost is typically financed by the solar developer’s funding partners or investors.

  
  

2. The Role of the ITC (Investment Tax Credit) and State Tax Credits

• Solar developers benefit from the Investment Tax Credit (ITC), which is currently set at approximately 30% of the system’s cost.

• Many states provide credits for solar systems, which is either 25% of the cost of the solar project or $2000, whichever is the minimum.

• For example, on a 7 kW system costing $25,000, the developer can claim $9,500 as a tax credit, reducing the financial burden and increasing the return on investment.

  
  

3. Understanding the Power Purchase Agreement (PPA)

Here’s how a Power Purchase Agreement (PPA) typically works:

Proposal and Agreement: The solar developer proposes a PPA to the customer. In this agreement, the customer agrees to purchase the electricity generated by the solar system at a predetermined rate, usually lower than the local utility’s rates.

System Installation: The solar developer finances, designs, and installs the solar system on the customer’s property. The customer incurs no upfront costs since the developer owns the system.

Ownership and Maintenance: The solar developer retains ownership of the solar system throughout the contract term (typically 10–25 years). They are responsible for all system maintenance, repairs, and operational costs.

Electricity Purchase: The customer agrees to purchase all or a portion of the electricity generated by the system at the agreed-upon rate. If the system doesn’t meet the customer’s energy needs, they purchase the remaining electricity from the utility company.

Financial Incentives: Since the solar developer owns the system, they are eligible to claim all federal, state, and local financial incentives, such as the Investment Tax Credit (ITC) and Renewable Energy Credits (RECs). These incentives help offset the installation costs for the developer.

Energy Savings: The customer benefits from lower electricity costs compared to traditional utility rates. Additionally, they avoid energy price volatility since the PPA often includes a fixed or predictable escalation rate.

End of Term Options: At the end of the PPA term, the customer typically has several options:

• Extend the agreement.

• Purchase the system at fair market value.

• Request system removal at no additional cost.

  
  

This model is popular because it allows customers to access solar energy without upfront investment while developers secure long-term revenue streams from the energy produced.

Here’s an example of a system:

• Rate Per kWh: The customer agrees to pay a set rate for the solar energy produced, such as $0.15 per kWh.

• Energy Production Example: A 7 kW solar system producing energy for ~7 hours daily generates approximately:

• 42 kWh/day → 1,260 kWh/month on average.

• Monthly Payments: At $0.15 per kWh, the customer pays:

• 1,260 kWh × $0.15 = $189/month.

• Annual Payments: Over a year, this amounts to:

• $189 × 12 = $2,268/year.

  
  

Cash Generated:

Based on the energy production and rate per kWh with the solar system producing 1,260 kWh/month and the customer paying $0.15 per kWh, the annual payment is $2,268.

How Solar Developers and Investors Get Paid:

• Solar Developer: The solar developer receives the monthly payments made by the customer, which is $189/month.

• Investors: Investors in the solar project may receive a certain percentage of the monthly payment. For example, typically investors get 80% of the total cash generated in years 1–10, and 20% for the rest of the solar project term.

  
  

Payback Period:

The payback period is the time it takes for the solar developer and investors to recoup their initial investment.

Detailed Financial Analysis of PPA Agreement Over 25 Years:

Here is a detailed financial analysis of the solar energy project over 25 years:

4. Additional Consideration

• True-Up Payments: Solar developers often provide a production guarantee. For instance, if the system is expected to produce 1,470 kWh/month but falls short, the customer may receive a refund for the underproduction at the end of the year.

• System Costs: The average cost of a 7 kW system (without batteries) is approximately $25,000, with financing enabling customers to avoid upfront payments.

• No NPV Consideration: The net Present value of the cash flow and overall transaction has not been taken into account.

  
  

How ABS Enhances Solar Energy Adoption

Asset-backed securities allow solar developers to pool customer financing contracts (like PPAs) into financial instruments. These instruments are sold to investors, generating immediate cash flow for developers and enabling further installations. This securitization model spreads risk and attracts institutional investment, ensuring a sustainable growth cycle for residential solar.

The emphasis on financing is a double-edged sword. On one hand, it democratizes access to clean energy. Conversely, it means solar companies often operate more like lenders than energy providers. This finance-driven approach is essential for sustaining growth, particularly as equipment costs decline and market competition intensifies.

If you would like to know what this means for your solar business, let's chat. We can work with you to simulate various quantitative models to assess NPV of projects, potential implications to IRR, Payback period, and suggest new strategies to remain competitive with or without ITC. Contact us at sanjay.bhatia@quantiedge.com, call/ text us at +1385-352-6820 or visit us at https://www.quantiedge.com/