Funding the sun: New Paradigms for Financing Off-Grid Solar Companies
Globally, about 840 million people lack access to electricity, most of them in Sub-Saharan Africa, where three in five persons still live without electricity (Tracking SDG7 Report 2019). Their lack of access hampers economic development, which holds back improvements in quality of life. More than 80 percent of Nigerian companies cite electrification challenges as the most significant obstacle to doing business, for example (World Bank 2017).
Sustainable Development Goal 7 (SDG7) calls for “access to affordable, reliable, sustainable and modern energy for all” by 2030. Given current and expected progress, this goal will not be reached. Advances in energy access have been impressive in some regions, such as South Asia, and recently accelerated in Sub-Saharan Africa, where for the first time in this century, electrification efforts have outpaced population growth. Nevertheless, according to the latest forecasts, the pace of progress is still insufficient to achieve universal electricity access by 2030. As a result, 650 million people globally, and 570 million in Sub-Saharan Africa, are expected to remain without electricity access by 2030 (Tracking SDG7 Report 2019).
Off-grid solar (OGS) energy provides an opportunity to increase energy access. Technology costs have fallen dramatically, and new business models, such as pay-as-you-go (PAYG), are addressing longstanding issues of affordability. More than 130 million OGS devices were sold between 2010 and 2018, with sales increasing at a compound annual rate of about 60 percent. Geospatial modeling by the International Energy Agency (IEA) suggests that 54 percent of Africans currently lacking electricity access could best be served by off-grid solutions, primarily solar (IEA 2017).
THE MASSIVE NEED FOR FINANCING
Substantial new financing sources will need to be identified, sourced, and advanced to allow OGS companies to increase energy access. Over 200 million people globally are estimated to benefit from the OGS products, and the sector has generated almost $4 billion in sales as of 2018 (World Bank Group 2018). To achieve SDG7, however, the sector is estimated to need almost $26 billion in financing (Shell Foundation 2018).
Established financing channels are not acting quickly enough to address the financing gaps in the OGS market, largely because of a mismatch between the structure of these instruments and the underlying business models of companies in the sector. Although some established financing channels, such as bank finance, remain important to the sector—particularly as OGS companies reach scale—they fail to address the nuanced financing needs of OGS companies across the business lifecycle.
UNIQUE FINANCING CHALLENGES OF OFF-GRID SOLAR BUSINESSES
The OGS sector and its value chain bring unusual financing challenges. Unlike traditional retail business models, the dominant OGS business model is asset-heavy, service-heavy, and consumer finance–heavy. The vertically integrated PAYG model has added consumer finance to off-grid company functions. The PAYG business model essentially rolls four business functions—product design/assembly, distribution, platform software, and banking—into one business (World Bank Group 2018). In this model, therefore, OGS companies provide not only technology and products but also finance.
The model introduces unique financing requirements, as companies must source capital for product development, manufacturing, and operations while juggling intense working capital and accounts receivable financing needs. In the OGS sector, the process of converting inventory into cash may take more than three years. The long cash conversion cycle, which runs from product manufacturing through the customer’s final loan repayment, can create a mismatch of credit terms and capital needs and/or restrict participation of financiers to those that are well acquainted with the sector.
The OGS sector presents additional complexity to financiers because of the limited liquidity of OGS assets, which limits their use as loan collateral. In addition to the credit term mismatch outlined above, transactions may be complicated by a currency mismatch between input costs and revenues, as customer repayments are usually fixed in local currency, while working capital and accounts receivable financing may be in hard currency. Transactions are also complicated by a currency mismatch between input costs and revenues, as customer repayments are usually fixed in local currency whereas working capital and accounts receivable financing are often in hard currency.
From a traditional financiers’ perspective, the OGS market represents a relatively risky investment. The market is relatively new and untested, comprising start-ups and growth-phase companies, and companies serve an untested customer base of remote, low-income households without credit histories.
Another complicating factor is the triple-bottom-line (social, environmental, financial) nature of investment in the sector. Different financiers may prioritize one type of return over another, which can be a problem for loan syndication or blended financing.
OGS sector, therefore, faces unique financing challenges. Finance for the sector has traditionally been provided by grant makers, impact investors, and development finance institutions (mostly in the form of grant and debt facilities). These sources of financing have been essential to nurture and launch the sector. They will be insufficient to scale the sector to its potential. Bringing the sector to scale will require greater participation from commercial equity and debt investors. Some commercial finance sources, such as local banks with specialized units for small and medium enterprises (SMEs), have made some investments in OGS firms, but they have yet to fully embrace the sector.
New financing opportunities are emerging now. The characteristics of OGS markets—distributed, data driven, based on novel technology—match new developments in the finance sector, often termed fintech. Although definitions of fintech differ, the term generally refers to applications, processes, products, and business models in the financial services industry that use technological advancements, often tied to the Internet, to provide improved financial services and activities.
These innovative financing tools build on the role of established financing instruments to broaden financial access, reach underserved markets, increase time efficiencies, and reduce the cost of capital.
This report provides a comprehensive overview of financing instruments in the OGS market for the full range of company investment needs, from pre-revenue start-ups to established commercial players.
Download the report below.