Efficiency Financing – Decide the Vehicle Before Discussing the Rate
In my first article about financing energy efficiency investments, I wrote about using equipment leases and financing agreements. In this article I’ll cover the most popular source of outside capital – the building owner’s commercial bank – and my thoughts on using loans and credit lines for equipment purchases.
As most know, the two most common forms of financing offered by banks to their business customers are corporate loans and lines of credit. Before getting into the details, it is important to note that not all building owners have access to either one of these financing vehicles, and even fewer have access to both.
First, let’s review each of them.
Building owners with a strong business profile, as measured by the amount of cash flow generated by the business in its normal course of operations, can often get corporate loans from banks at prevailing market rates. Typically, the business can obtain short or long term corporate loans to fund their business needs such as for raw materials and expansion of the business, among other things. Business owners enjoy relatively low interest rates, adjusted for the risks involved – determined by the bank for the type of need that the loan is utilized for. The interest rate starts with a base rate such as the WSJ Prime (Wall Street Journal Prime) rate or LIBOR (London Inter-Bank Offering Rate) plus a spread such as 2%, 3%, or more. The amount of the spread is determined by the bank based upon numerous factors such as loan term, credit worthiness of borrower, purpose of the loan and so on.
Generally, corporate loans have fairly low interest rates compared to other types of financing. However, the bank will not fund 100% of the project, often limiting the loan amount to 80% (or less) of the equipment cost. The percent financed is driven by the perceived risk of the purpose of the funds, as well as the bank’s internally decided risk tolerance. Another thing to consider about a corporate loan is that the bank typically will require a first lien on all assets of the business such as inventory, reserve funds, property, plant, and equipment, etc. If the business is unable to repay the loan, the bank has the right and ability to seize assets. Finally, corporate loans generally do not cover soft costs, like engineering, which can be substantive amounts with energy efficiency projects.
Line of Credit
Businesses with strong cash flow that either have a cyclical nature to their business or have needs to stock up on inventory or raw materials typically have a line of credit to support their operations. An example of a cyclical business could be a snow shovel manufacturer. That manufacturer sells most of his product during the winter. However, in the spring and summer, he needs to buy the materials and manufacture the shovels. So, he may obtain a line of credit, which is similar to having a credit card, to pay for raw materials and manufacturing, and then pay it down as he sells his shovels during winter.
A line of credit can have a low interest rate consisting of a base rate and a spread. Lines of credit can also have some flexible terms, such as allowing the business owner to make payments of interest only during the year, and then pay off the principal amount borrowed at the end of the year or sales cycle. Rates on lines of credit are typically low because the bank often collateralizes the line with the inventory that finances. Additionally, the bank will seek to take an assignment of other assets, such as accounts receivables.
Things to consider for energy efficiency projects
Although using bank loans and lines of credit to finance energy efficiency projects is viable for some business owners, I tend to advise against it. Why? It’s not what they’re intended for. Corporate loans and lines of credit should be used for the business’ operations. Using these vehicles to pay for energy efficiency equipment reduces how much a business can borrow to fund their business needs. And, any money used from the bank used for equipment and other capital equipment is money that’s unavailable for any short-term operating expenses. In short, it’s best to use bank financing for operations, not assets.
In closing, I’d like remind all the readers who are selling energy efficiency equipment and services that it’s imperative to be proactive in helping building owners make the right financing decisions. As I’ve seen many times, discussions often digress into discussions about rate before the borrower has decided which vehicle is best. Decide the vehicle (lease, loan, etc.) before discussing rates – rate is very important, but rates on leases are different than rates on loans because a lease is very different a loan. Help the building owner make an informed financing decision about what financing vehicle and then work to get the best financing terms.
Michael Park is a transactional finance professional with Noesis Energy.
- NAEM 2015 EHS and Sustainability Software Buyers Guide
- 2015 Environmental Leader Product & Project Awards
- How "Fixed" is the Fixed Price Product?
- Improve Your Company's Environment and Energy Performance
- 2015 Insider Knowledge
- Energy Manager Today Awards Top Products and Top Projects of the Year
- Practical Insights into the Implementation of GHS Around the Globe
- Beyond Compliance: Applying a Risk Lens to Your EHS Practice
- Just the Facts: 8 Popular Misconceptions about LEDs & Controls
- A Roadmap for Effective Process Safety Management