The L 3 C and Alternative Energy Funding Discussion Concepts for Renewable Energy L 3 Cs with Foundation and Non-Profit Funding By: Robert Lang Americans for Community Development Michael Zimmer Thompson Hine, LLP and Ohio University Voinovich School for Leadership & Public Affairs Michael Mendelsohn
Introduction Financing remains a significant hurdle for the development of renewable energy (RE) projects in the United States, despite the existence of support policies at the state and federal level. Innovative approaches, such as advanced financial structures and master financing facilities, can overcome this hurdle for certain developers and projects, but these financial innovations require a level of developer experience, aptitude, and project security that can lock less attractive developers and projects out of the market. A new approach to RE project financing, one that may sidestep otherwise formidable hurdles can be found in the L 3 C (Low-Profit Limited Liability Company). An L 3 C is a business entity formed to finance socially minded projects and organizations, and may include funds from non-profit or for-profit entities (Witkin 2009). Its purpose is to attract a range of investment sources for socially beneficial, limited-profit ventures, and thereby improve the viability of such ventures. As L 3 C structures are very new, there are no known examples of an L 3 C structure to support the financing of an RE project. Nonetheless, the L 3 C organizational structure could potentially help non-profits play a pivotal role in the deployment of proven and emerging RE technologies. The authors would like to thank Karlynn Cory, David Kline of NREL(National Renewable Energy Laboratories) for their contributions. The authors also wish to thank Mary Lukkonen and Scott Gossett of NREL s communication department for their technical edits and support. The authors would also like to recognize the contributions of Renewable Social Benefit Funds, L 3 C (RSB Funds) to the renewable space and advancement of the use of PRI s to fund sustainable renewable energy projects. Founded in 2009 RSB Funds has promoted the use of renewables by nonprofits as a way of reallocating energy related overhead to core programs. This focus has attracted the attention of the White House Office of innovation and the foundation community. RSB Funds is currently in the process of developing a Los Angeles based PRI funded solar project that will serve as the first of what we hope will be many examples of the power renewable energy and PRI s can provide our communities.
Capital Issues Relevant to Renewable Energy Projects High initial development costs and limited access to capital hinder the deployment of RE electric-generating projects. Depending on the customer s creditworthiness, direct support from its utility or state, and other factors, external funding may not be available. Accordingly, many commercial and foundation entities lack the capabilities to implement an RE project because of these scale limitations. Further, to the extent external funding is available, it is only provided for projects that utilize bankable technologies with extensive operational track records. Newer technologies that lack a commercial track record, even if proven via pilot projects, lack the access to capital necessary to implement large-scale manufacturing and commercial deployment. This complex barrier is often referred to as the Finance Gap, or Valley of Death. In a recent series of questionnaires designed by the National Renewable Energy Laboratory (NREL), respondents indicated that an array of financial considerations constrain project deployment (NREL 2010). Participants of the questionnaires indicated financing-related barriers (including raising debt, finding tax equity investor, the creditworthiness of the power purchaser, and accessing government incentive programs), in total, represent the primary barrier to successful project deployment 47% of the time. Accessing government incentive programs 11% Other 17% None 8% Raising debt 11% Finding tax equity investor 12% Project economics 10% Technological hurdles 6% Environmental permitting 5% Transmission 7% PPA / creditworthines s of power purchaser 13% Of particular concern to investors is scant operating data, particularly for newer
technologies or from newer manufacturers, on which to assess performance reliability. The creditworthiness of the entity buying the electricity (particularly if the power is sold directly to an end-use customer such as a hospital or museum) is also of concern along with the availability of the transmission capacity to carry the power. Further, investors thoroughly assess the credit quality of the equipment manufacturers to ensure long-term performance guarantees and warranties of the deployed RE technology can be upheld for the entire contract period. To support the financing of RE projects, the U.S. government has established several support structures all relying upon the tax system, which are of limited use to nonprofits and the foundation community. The two most critical mechanisms offered by the federal government are: (1) investment tax credits (ITC) or production tax credits (PTC) and (2) an accelerated depreciation schedule known as the Modified Accelerated Cost Recovery System (MACRS). Both the ITC/PTC and MACRS mechanisms can benefit the renewable project by reducing the taxes payable, thereby improving the economic performance of the project. In total, the tax credit benefit of the mechanisms can represent roughly 56% of the installed cost of the project (Bolinger 2010) if available. However, these federal policies have created their own complexities and consequences. In particular, RE projects generally do not produce sufficient taxable income to take full advantage of the tax credits. The credits can be carried forward, but that greatly reduces their present value to an investor. Accordingly, RE project developers attempt to sell the tax credit benefits to a tax equity investor who has profit from other business activities, or tax appetite, to utilize the tax benefits created from RE projects. This frequently creates complexity and requires significant investment in due diligence, analysis, and contracts to protect the parties to the RE transaction. These limitations unduly constrain the industry s access to capital from a small group of financial or institutional investors such as insurance companies.
A New Approach Now, a new type of business organization, the L 3 C, could offer unique solutions to many of these problems. The L 3 C is a variant form of the limited liability company, or LLC, but specifically enables a divergent mix of corporations, individuals, non-profits, and government agencies to organize under one umbrella for a charitable or socially beneficial purpose. Like all LLCs, the L 3 C is essentially a partnership with corporate protection. An L 3 C can include for-profit or non-profit entities, but has no definitive structure or required participation of any entity type. The L 3 C can also serve to attract the right foundation with a compatable mission to become a member and use this investment vehicle alternative. The L 3 C is a for-profit venture that, under its state charter, must have a primary goal of furthering an exempt purpose. An exempt purpose is essentially a charitable or socially beneficial purpose but slightly more restricted since it must fit within the definitions in the federal regulations for PRIs (Program Related Investments). Project investments made under an L 3 C can be used to lower the risk profile or reduce the cost of capital for a particular project. The model essentialy turns the venture capital model on its head since the foundation takes the first tranche or first risk portion of the investment but at very low rates rather than the high rates normally demanded by venture capitalists.the L 3 C can be a financing vehicle for scientific research, economic development, energy research, operation of social service agencies, museums, concert venues, housing, and any other activity with both a charitable purpose and a revenue stream. The L 3 C structure was first enacted by Vermont in April 2008 and has since been enacted in eight other states Illinois, Michigan, North Carolina, Maine, Utah, Wyoming, Louisiana, Rhode Island and two Native American nations the Crow and the Oglala Sioux (Americans for Community Development 2011). Like a Delaware corporation, an L 3 C entity from one of the nine states can be used anywhere in the United States. The L 3 C possesses flexible membership rules that allow structural latitude to meet both project and non-project needs. L 3 Cs can develop social purpose missions, making it easier for socially motivated investors to locate the branded L 3 C that satisfies their needs and investment objectives.
Per IRS regulations, foundations are required to spend 5% of their net assets on charitable giving every year (Lakamp et al 2010). Generally, to comply, foundations extend grants to charitable organizations, which they attempt to resupply via return on the investment of their endowment. Roughly forty years ago, Congress enacted laws that allow private foundations to comply with the charitable giving requirement via investment in a for-profit entity (Owens et al 2009). The strategy, using PRIs, allows private foundations to make equity investments in for-profit entities, as long as the investments significantly further a taxexempt purpose of the foundation and its goals and satisfy other requirements While the PRI opens investment opportunities specifically for foundations, the L 3 C further expands the concept to include any combination of non-profit and for-profit entities. As discussed above, renewable energy projects rely heavily on various tax benefits to improve the cost of the associated power and induce investment. However, renewable energy projects and the developers who build them generally lack the tax income to utilize the tax benefits to their full value. Accordingly, a separate tax equity investor is sought to invest in the project. Because non-profits have no use for tax credits or depreciation, they cannot take direct advantage of the tax benefits. With the L 3 C structure in place, the tax benefits can be concentrated and absorbed by a tax equity investor that has the tax appetite from other businesses to utilize. The ideal project will be able to take advantage of both tax benefits and the low cost of capital provided by the foundation participation. The L 3 C allows the tax benefits to be fully utilized, thus lowering the cost of energy to the end user by accessing a wider base through foundations and non-profits. Importantly, tax equity investment is quite constrained in the wake of the financial crisis and due to specific expertise required to invest in renewable energy projects. Accordingly, only the largest projects with the most credit worthy customers generally go forward. A smaller RE project with an unrated entity (e.g., a museum, an organic farm, or a housing development) has very limited opportunity to attract investors for the purpose of utilizing the array of complex tax benefits available.
However, through the L 3 C, the project can allocate risk specifically to the non-profit entity, improving the risk-reward profile for the tax equity investor and, in turn, greatly increasing the chances of attracting tax equity. The L 3 C s non-profit entity can attract and assemble a new mix of investors that would otherwise consider the non-profit too risky to invest in. This is accomplished through tranched investing, in which the foundation assumes the primary risk of default at a low return to attract higher levels, or tranches, of investment. With the primary risk covered, the creditworthiness of the remaining L 3 C is enhanced, and the total cost of capital is reduced (see chart below). This, in turn, increases the availability of capital investment from traditional sources such as tax equity and debt. The results are most effective where non-profit investors can make a valuable contribution to a project that needs to be structured and documented carefully and with competent, experienced counsel. The L3C investment becomes the foundation for more traditional sources of capital Equity Debt L3C Funds
L 3 C Examples As the L 3 C structure is brand new, there are a limited number of examples of completed projects to draw upon. Nonetheless, based on an analysis of all L 3 C allowing states and territories, 440 L3C structures have been organized as of July 22, 2011 (Lang, 2011). Though to date no known L 3 C structure has centered specifically on an RE project, the concept of the L 3 C has promising implications for RE technology deployment. L 3 Cs have been established for a wide array of economic sectors including (Capriccioso et al, 2010): Farming and agriculture Real estate/housing Socially responsible consulting Environmental services Education Healthcare Low-income assistance Construction services Journalism and publishing Financial and legal services Entertainment industry Some specific examples of L 3 Cs are represented in the following: An L 3 C in St. Louis, Missouri, Mission Center L 3 C, was organized to provide back office services at reduced rates to L3Cs and non-profits (Lang, 2011) The L 3 C structure allows the center to provide a wide range of services and incentivize employees to reduce costs. The Mission Center L 3 C serves a wide range of non-profit and L 3 C customers. The services offered include accounting and human resources. The L 3 C is organized in Michigan and currently only provides services in Missouri and Illinois. The Mission Center started with a loan from wealthy supporters and is doing business while securing equity from foundations and individuals.
An L 3 C structure, Endless Sky L 3 C, will be used for a new food processing facility in Montana to serve the Montana Food Bank (Lang, 2011). The company will also produce a high-end retail line of food products that will pay all the costs of processing food for the food bank. The facility will include its own greenhouses and use waste materials for energy production. It will be structured with a combination of debt and equity (Lang, 2011). An L 3 C structure was created for the benefit of organic dairy farms in Maine that needed a market for their organic milk (Zouhali-Worral,l 2010). The L 3 C, Maine s Own Organic Milk L 3 C, or MOOMilk, was developed to process and market organic milk from 10 farms in Maine with the assistance of the Maine Department of Agriculture and local non-governmental farming organizations. Because the Maine Legislature had not yet approved L 3 Cs, the company incorporated in Vermont to obtain L 3 C status. It then registered in Maine as Maine s Own Organic Milk Company, L 3 C, LLC. The Fresh Food Financing Initiative (FFFI) is a $120 million program to bring healthy foods to low-income neighborhoods in Philadelphia (Harris, et al 2011). FFFI is a collaboration of the Food Trust, a nonprofit founded in 1992, the Commonwealth of Pennsylvania, and The Reinvestment Fund, a community investment organization. The venture started with an initial five-year $30 million grant from the state along with a 3:1 TRF state-dollar match to catalyze private capital investment (Harris, et al).
Hypothetical Renewable Energy L 3 C Project No known L 3 C structure has centered specifically on an RE project to date. Accordingly, the following hypothetical example was developed to illustrate how an L3C structure could facilitate an RE project. Safe Kids, Inc. is a social services entity, organized as a 501(c)(3), providing children safe after-school programs. They operate on a tight budget and, although they have provided services for 50 years, continue to rely on state grants and donations to pay for operations. Solar Innovations, LLC, designed a marketable new technology but cannot attract financing to bring their product to market. Together, Safe Kids and Solar Innovations formed an L 3 C to support development of Solar Innovations technology, reduce energy costs for facilities of Safe Kids and other non-profits, and encourage the use of greener technology. To attract and leverage non-profit investments, utilize the array of tax benefits at the federal and state level, and attract market-rate investments from the community and abroad, the L 3 C was financially separated, or tranched, into three components: Debt allocated to fixed income investors with a yield of 7.5%. Tax equity from an entity that could take advantage of the ITC and accelerated depreciation benefits. The investment provides a target return of 10%. Equity from foundations with a low expected annual return of 2%. The blended rate for the overall structure is 7.25%, well below what might be expected with 100% commercial financing, if it was available at all. The lower rate translated into a lower cost of power for Safe Kids Inc., Solar Innovations LLC benefitted significantly by deploying their technology at commercial scale and garnering a stronger operational track record and commercialization of its technology. A foundation s support in the acquisition of Safe Kids Inc. s solar system translates effectively into a multi-year gift in the form of lower power costs in Safe Kids Inc. s
operating budget. This gift s value will continue to grow each year as power costs increase in excess of the fixed contract rates and as electric rates escalate. The foundation s L 3 C membership stake provides for a lower rate of return and is subordinate to other investors. Its stake can be at the highest risk, early stages of RE project development. With a tranched L 3 C structure the investments can be sought and made in stages as development proceeds on a risk-adjusted basis. If the company is sold, the foundation can benefit from an equity kicker. With this flexibility, the remaining L 3 C members capital contributions or interests are marketed at rates of returns and risk levels necessary to attract market-driven investors. This would also provide the basis for an exit strategy for the market rate investors. Debt (gets paid first) Tax Equity Investment (takes tax credits) L3C to develop solar project on SafeKids facility using Solar Innovations technology Non-profit Investment (gets paid last) Non-profit receives return of and on investment Solar Innovations market its innovative technology Safekids receives low cost-electricity, reduces operating budget
Conclusion The L 3 C offers U.S. non-profits a powerful new tool to achieve their mission, as well as assist in the development of socially beneficial enterprises. This kind of structure has strong implications for RE deployment especially in the case of emergent technologies and could help projects overcome financial barriers that could have otherwise resulted in delays, increased energy prices, or abandonment. L 3 Cs are new organizational structures and thus have limited examples to draw from, but can be creatively applied to support RE deployment in socially beneficial purposes for non-profits and NGOs and diversify the base of fund raising for projects beyond merely grants.
References Americans for Community Development (2011) What is the L 3 C? available at http:// www.americansforcommunitydevelopment.org/downloads/what%20is%20the%20 L3C%20080711-1.pdf Bipartisan Policy Center (2011), Reassessing Renewable Energy Subsidies: Issue Brief Bolinger (2009), PTC, ITC, or Cash Grant? by LBNL and NREL Capriccioso (2010), Who is the L3C Entrepreneur? The Pioneers of Social Enterprise s Revolutionary New Suffix, intersector Partners, L3C, May 2010 Gelman (2010), 2009 Renewable Energy Databook, Department of Energy, August 2010 Harris, Murray, Burkhardt (2011), Navigating the New World of Social Impact Investing: An Opportunity and Challenge for Foundations, The National Forum on Higher Education for the Public Good, and January 2011 Lakamp, Pasciak (2010), For Some Foundations, Charity Extends to Home Office, Buffalonews.com, October 2010 Lang (2011), Phone conversations with Robert Lang, January August 2011 Niver (2011), Phone conversation with Mike Niver, CFO of SolarCity, June 2011 (a) Owens, Tyler (2009), The L3C: A potentially useful tool for promoting charitable purposes, Community Dividend, November 2009. Witkin (2009), The L3C: A More Creative Capitalism 2. Zouhali-Worrall (2010), For L3C companies, profit isn t the point, CNNMoney, February 2010 For More Information Regarding the L 3 C Visit Our Website: americansforcommunitydevelopment.org 2010-12 Americans for Community Development LLC 080711-01