Financing ‘energy localism’, how does legal structure matter?

The message from the energy prices summit last October was only “check, switch and insulate”. Why not “generate”? Amid the threats of soaring energy prices and global climate change, it gives us every reason to go ahead with ‘energy localism’ – community sustainable energy projects – which can fuel local green growth. Unless you are lucky enough to have a hidden goldmine in your community, it is often the financiers, not the business angels, who can give an energy project green light.  

Any community organisation has to be incorporated with a legal structure before it can seek financing. For enterprises with social missions (social enterprises), the government recognised that traditional legal forms pose an obstacle to raising finance. For example, companies limited by guarantee and charities are not allowed to raise equity which is often essential for a distributed generation project that needs substantial investment. Their weak brand makes financiers wary and increases the cost of funds. Introduced half a decade ago, some ‘tailor-made’ legal vehicles such as community interest companies (CIC), industrial & provident society (IPS) for the benefit of the community (BenComm) and bona fide co-operative (Co-op) are increasingly adopted by community enterprises. Are these new models really a blessing for social entrepreneurs when raising finance and tackling local sustainability agenda?

The answer is not that straight forward. It depends on the ‘bankability’ or robustness of your energy project. Bankers in the City want stable and predictable cash-flows at known risk. Equity funders wants maximised returns to equity at known risk with a pathway to exit or repayment within a determined horizon, say 5-15 years. Their specific considerations on a local renewable energy project may include the risks of technology, credit-worthiness, revenue security, market competition, scale and related costs issues. If you benefit from the government’s feed-in tariff and renewable heat incentive, your project will be awarded a higher score on bankers’ desks. But the scale of a local energy project that is typically smaller than large infrastructural projects remains a stumbling block due to the transaction cost being relatively prohibitive. It seems a CIC or BenComm, featuring social responsibility, “asset lock” and democratic governance, has not gained a clear edge over other competing proposals in the City.

If so, let’s turn to community financiers looking to invest in social enterprises and co-operatives. They are looking for ‘robust’ energy projects which can offer competitive returns in the commercial market while emphasise broader community benefits. With regard to legal form, their line-to-take is that an investment decision is more about the “substance” than the “form” of the enterprise. Funders prefer to support companies with clearly articulated social aims and objectives as well as the power to borrow in their governing documents. In the case of Co-ops, they only lend to those with at least 51% of shares controlled by employees.  Even if there is no “asset lock” in a company’s structure, funders will look for clear policies regarding dividends, directors’ remuneration, shareholding and dissolution which reflect the distinctive profile of a community renewable energy enterprise. In some cases, funders may negotiate with the borrowers to set up a quasi “asset lock” arrangement or a minority stake in their article. Thus, in fact, socially responsible financiers do look for what CIC and BenComm are legally required to offer. Perhaps the regulations governing CIC and BenComm appear to be more appealing to private investors for a mixture of pecuniary and social/environmental returns.

Legal structures do, nonetheless, matter in terms of asset allocation – forecast rate of returns – in the considerations of financiers. Particularly in the context of community-owned energy projects, a Co-op can attract more capitals than BenComm and CIC. Both types of IPS, Co-op and BenComm, guarantee community engagement, one-member-one-vote governance and to pay interest on shares, but BenComm lures less capitals as all surplus from business is not allowed to go for dividends. In CIC, no more than 35% of surplus is distributable and the dividend per share is limited to the Bank of England base lending rate plus 5%. These restrictions render CIC difficult to invest because the performance-related income is too low in the eyes of financiers. Therefore, if a CIC is mainly supported by grants from local authority, the payback period is unattractive in the market. By comparison, the more attractive financial returns explain why Co-op dominates in the renewable energy field.

Email me at winstonkm.mark@googlemail.com


Read the full article to be published in the next edition of EG Magazine.