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For Organizations and Social Entrepreneurs

Formation and Financing

Not all PPESCOs have to be created in the same way. Several structural options are worth considering. Private or public, for profit or nonprofit, organizations interested in forming a PPESCO should consider creating a separate subsidiary that is structured to optimize both mission fulfillment and funding.

Forming and funding a PPESCO

PPESCO operations are such that an entity can be formed and managed by a sponsoring organization. In many cases, this could be the entity’s parent organization.

It is important to note: The profit imperative of a company that has no social or environmental mission limits its ability to offer whole-building energy improvements and a corresponding financial package that yields deep energy savings to the broad, public-purpose market of small to medium-sized buildings.

The information presented here is not, and is not intended to be, legal advice. This information is intended to provide an overview of possible choices of legal structure for PPESCO entities.

This information cannot substitute for the advice of a qualified legal professional. Any individual or organization that seeks to form a PPESCO should consult with an attorney for advice relating to specific circumstances and business objectives.

The legal, financial, and cultural elements needed to start and grow a new venture are critical to a PPESCO’s formation.

PPESCO organizers will need to choose whether a for-profit entity works best, or whether it should be a nonprofit or hybrid organization. PPESCO organizers must also determine whether a subsidiary within a company or a company department or division can be that entity.

The sponsor of a PPESCO might want to consider a separate, wholly owned entity. One flexible and straightforward choice is a limited liability company (LLC), although other types of legal structure might be better suited to the specific circumstances of a particular organization.

LLCs have the following features:

  • Legal: LLCs can limit liability for their owners, a protection for any subsidiary that might be faced with a legal or financial claim related to the PPESCO's work.

    If the sponsor has a comparatively large asset base, an appropriately structured, governed, and capitalized LLC subsidiary can protect the parent organization’s assets.

    Despite the fact that an LLC provides a legal and financial buffer for the parent organization, the parent organization still retains ownership of the entity and governs it. The role of the parent is to ensure that the PPESCO is operating consistently with the parent’s purpose, whether social or commercial.

    Note, however, that if the composition and activities of the subsidiary are too closely related to those of its parent organization, it faces the risk of being declared a “mere instrumentality” of the parent. This designation makes the parent vulnerable to claims against the subsidiary entity for any debts and obligations. A qualified legal professional should be consulted so that this risk can be minimized.

  • Financial: LLC subsidiaries of parent organizations open the door to institutional, private-sector, and public-sector capital. Tax-exempt nonprofit status of a mission-driven parent organization gives it some distinct advantages. Most notable of these advantages is that the parent can attract foundation and social-purpose capital to support both operating expenses and project investments.

    With a separate entity structure for a PPESCO, the parent can provide arms-length administrative and other back-office support to the LLC, under the terms of the contract between them (see The PPESCO and its parent organization, below).

    Likewise, a PPESCO’s access to and distance from its parent can be beneficial. That is, to the extent that the PPESCO entity and its parent are aligned by mission and values, the PPESCO also needs to operate with sufficient agility so that it can adjust quickly to unforeseen challenges that all start-ups experience. The needed degree of flexibility might not be consistent with the operating norms of the parent, but if the PPESCO is operated separately from the parent, there is a greater likelihood of meeting those start-up challenges.

The PPESCO and its parent organization

The separate PPESCO entity can inherit its parent's brand and purpose, all while developing an identity unto itself. Although the PPESCO might want to create its own identity, fully shared values should exist between the parent and its PPESCO. This identity can evolve as the PPESCO matures through its business phases and in the context of the substance of its core business.

In addition to the PPESCO’s legal considerations as an operating business, it also has other considerations related to its relationship with its parent organization. These should be defined and agreed upon with the parent organization. They relate primarily to services and shared resources such as:

  • Back-office services: accounting, finance, human resources, and other essential administration
  • Management services: strategic support for operations leadership
  • Investment capital formation support: sharing access to known capital resources to help advance the PPESCO enterprise

Financing

A successful PPESCO will typically need three types of financing:

  1. Start-up capital. As in most new ventures, operating expenses are incurred ahead of revenue, creating losses in the entity's first few years.

    PPESCO-interested sponsors will need to make a significant effort to secure capital to support these losses. This capital can come from an internal, parent-provided loan, for example, or it might take the form of program-related investments (PRIs) from foundations or other types of social-enterprise investors.

  2. Project financing. The PPESCO’s stock in trade is building energy improvements. These are largely financed by debt that will be serviced by future energy savings to the building owner and repaid to the investor.

    Because the building owner’s equity in the property might be limited, and / or the ability to use the building for collateral might be limited, project financing must consider the level of increased cash flow to the building owner from post-project energy savings. Any PPESCO will need to invest resources in soliciting and securing significant project capital from investors, starting with “friendly” and “patient” investment sources. These can be PRI and social enterprise capital; later, funding can be obtained from other sources.

    The amount of debt raised should be sufficient to support:

    • debt service
    • ongoing PPESCO support services after the project is complete
    • positive cash flow for theowner at approximately 5% to 10% of pre-improvement utility costs

  1. Credit enhancements. Backing a PPESCO’s guarantee of energy savings, especially in early years, a loan loss reserve or stand-by letter of credit, provided by third party patient capital sources, may be necessary. Both the loan loss reserve and the letter of credit provide credible assurance to investors that payment will be made regardless of adverse circumstances.

PPESCO entity financing

To raise either internal or external capital, the PPESCO needs a business plan. The plan must contain a multi-year projection detailing the venture's operating and financial requirements. Supporters will look for a standard financial statement—a document that contains an income statement, balance sheet, and cash flow projections.

This table provides a list of the necessary components for an income statement.

Income Statement Component Description
Revenue Generated by the PPESCO’s one-time construction project services to the building, and annual payments from the building owner for monitoring after the project is complete
Cost of Revenue Labor costs (plus mark-up) for delivering those services
Gross Margin = Revenue - Cost of Revenue
Operating Expenses Costs associated with the PPESCO management, marketing, sales, and other typical business operations
Financing Costs Costs associated with borrowing to support early PPESCO growth
Net Income = Gross margin - Operating Expenses - Financing Costs

Project Financing

Project financing will first be sought from commercial asset and cash flow lenders (for example, banks and credit unions) and / or from community development financial institutions (CDFIs). Building owners might be best served by asset-based lenders with whom they already have a borrowing relationship; those lenders might be more willing to extend additional credit for asset improvements, with or without credit enhancements.

There will be instances in which financial institutions will not extend additional credit. In such cases, a combination of mission-driven lenders—most likely, foundations—and other social-enterprise investors can extend credit. This is particularly the case if the missions of such lenders and investors align with those of the public-purpose building owner, and if the prospective cash flow from energy improvements is sufficient to give them confidence that the funding will be recovered. Further, the chances of support from these lenders and investors are likely to be strong because the public-serving entities perform needed functions in the communities they serve.

PPESCOs that organize projects into market sector portfolios (affordable housing projects, for example), might attract financial support from specialized sources that share a mission to serve that market. Defining portfolios is an important organizing theme for a PPESCO. It lays the groundwork for attracting both current and future capital. Certain types of buildings might have access to specialized federal or state resources for capital, credit, and incentives.