Secure Financial Feasibility

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Introduction

With only about 55% of the population having access to electricity (IEA et al., 2020), Nigeria is an attractive market for off-grid solar companies. This section will outline the challenges standalone solar (SAS) and mini grid developers face while accessing finance for their businesses, and provide some guidance on what can be done to tackle these.

This section will firstly describe different key components of financing. Afterwards three challenges of accessing finance are highlighted, followed by three different guiding principles, each of them illustrated by practical examples from established companies. Please keep in mind that this section focuses on business financing and how to access finance for your company. Accessing finance is only one part of a successful business model.

For more details on this area, please also consult the “Designing management and business models” section.

Definitions

There are three funding sources that should be considered when searching for financing options in the off-grid sector. This chapter will give an overview of the most common options. Which options are most suitable for which company stage, will be discussed in detail later in the chapter “Different types of financing are needed during the lifetime of a company”.

What is a Grant?

A grant is a non-repayable award, mostly offered by governments or donors. Companies usually have to face a selection process in a competition with other applicants.

What is Equity?

Investors are buying shares of the company in order to make money through dividends or by selling their stakes. What is Debt?

Unlike grants, debts are borrowed funds which have to be repaid plus the amount of interest. Debt finance is the main used instrument in the SAS and mini grid sector.

Challenges in raising finance

The off-grid electrification sector is growing and attracting more investments and financing. However, there are still difficulties in accessing funding, especially for smaller companies which have been unable to raise equity. Therefore, most of the funding flows to large, established companies. This section focuses on the main challenges off-grid solar (OGS) enterprises face when raising finance.

Lack of sufficient financing supply

A main barrier to access funding is the lack of affordable long-term loans. OGS business models are considered very risky as they are quite new and have only a limited track-record which leads to investors expecting only low profits. Besides most of the local investors are not familiar with the credit risk analysis of OGS projects and are therefore skeptical whether a significant cash flow can be generated. Consequently, they are demanding high interest rates and rigid collateral requirements. Especially private local finance suppliers like commercial banks offer debts on extremely high interest rates. Furthermore, despite progress across the industry, factors like perception risk, complex fund design and the time frame required to get through regulatory compliance prevent the disbursement of concessional capital. Concessional funding is needed to unlock commercial investments by decreasing investment risks and to scale up the business. In general, a lack of subsidies, which are needed to close the viability gap of high development costs and the low-income of rural households, in the sector exists (ACE TAF, 2021b, 2021a; Adamopoulou et al., 2022; GOGLA, 2022).

Entrepreneurs are not ready to absorb finance

Many OGS companies are not ready to raise or absorb external capital given their current scale of operations. Smaller companies have shown limited ability to evaluate investment needs and prepare for a capital raise process. Furthermore, smaller companies also have smaller financing needs that are often outside the minimum requirements of investors. Accordingly, companies find it more difficult to access finance, especially at an early stage (ACE TAF, 2021b). Another barrier is the long and elaborate licensing process for mini grid developers. 80% of the compliance time is taken up by licensing, whereby Nigera has the lowest compliance time compared to other african countries. Unlike large-scale power distributors, mini grid developers have to go through the whole regulatory cycle for every 100kWs installed. OGS companies therefore are only operating under limited open market principles, which affects the investments, bankability and profitability (Adamopoulou et al., 2022).

Currency risks

Inconsistencies in local currencies as well as foreign exchange rates lower the ability to absorb funding and manage import costs. Local currency lending is mostly disbursed and repaid in hard currency like dollar or euro, while debt services are fixed in local currencies. In the case of a devaluation or inconsistencies, for example through a pandemic, the borrowers may suffer financial loss. To reduce foreign exchange rate risks, the use of debt financing in local currency offers should be considered (AFDB, 2020b; Hirschhofer and Mittal, 2021; GOGLA, 2022).

Guiding Principles

The following chapter provides guiding principles, consisting of solutions and examples, for the problems highlighted above.

Target financing that is suitable for the stage/ maturity of your company

When entrepreneurs are looking for funding, various aspects have to be taken into account. Depending on the business stage, a company needs different types of financing. Start-ups, with a high-risk profile, tend to rely mainly on grants. Once a project has received sufficient grant funding, it is financially viable for private sector funding and scaling-up (REA, 2016).

For scaling-up their operations developers need access to affordable debt as well as equity. As early-stage companies mostly have not been able to generate much capital, it is more difficult for them to prove their profitability and take out loans. Debt providers such as banks expect to see a track record of profitability in potential investees (Yakubu et al., 2018). Concessional financing facilities including debts at subsidized interest rates or credit-risk guarantees, provided by development banks for commercial lenders, should be considered. Many different funding opportunities exist, which offer grant, equity and debt. Existing search platforms can help to find suitable offers and application documents quickly.

Example:

The Green Village Energy (GVE) project is the largest mini grid developer in Nigeria. Electricity is distributed to communities through a network of retailers. Before GVE received its first grant, the company raised its first round of investment through family and friends. Subsequently, the company received funding in the form of grants from REA, USADF and the USAID Power Africa programme, which also provided transaction advisory support. Furthermore it received loans from the Bank of Industry, which is now a shareholder, and equity as well as debt funding through the impact investor All-On. Although GVE has already received a lot of funding, it has not been able to access credit from local commercial banks due to high interest rates (AFDB, 2020a). For further information to GVE see also the case study.

Consider both foreign currency and local currency financing

The Nigerian market for off-grid solar products is mainly driven by foreign investors. In the meantime, there is an increasing number of local financing options, such as commercial banks or government funding for example through REA. Developers often require hard currency finance in order to pay for their equipment imports. However, this may be accompanied by a potential shortage of foreign exchange. Foreign currency risks can be mitigated through the use of local currency debts, but these are often characterized by higher interest rates. Because of the unaffordability of local currency debt finance, companies are reliant on equity finance. When selecting suitable funding, both local and foreign currencies must be taken into account (AFDB, 2020a).

Example:

The African Development Bank (AfDB) launched with the European Union the DESCOs financing programme in 2018. The programme aims to remove barriers to accessing finance and support growth and expansion into new markets. For this purpose, access to local currency will be facilitated by providing risk mitigation tools to local lenders. This includes partial credit guarantees (PCG) which cover a part of the debt that companies receive from their lenders and credit enhancements which allow the local finance institutions to provide more favorable long-term debts (Ben Abda and Miyares, 2019; Mpoke-Bigg, 2019).

Exploit all opportunities for capacity building and technical assistance

Most financing is going to international companies, partly because Nigerian-capital companies are relatively new (3-5 years). Capacity building can lead to more funds being mobilized. An ACE TAF study found that only 21% of surveyed solar technicians across Nigeria had any formal training on repair of solar products.

Another method to improve investment readiness and transparency is detailed financial management. Investors usually want to see statements about past and projected financial performance and expect transparency from companies. An adequate record of key financial and operational performance indicators is beneficial. Technical assistance, e.g. in the form of tools, can help to collect this data. To model and assess the economic viability of mini-grid investments, instruments such as MEI's financial feasibility assessment tool exist. By inputting all key data, the model shows the most important features and gives sufficient feedback to fully understand and analyse the economic performance of the target mini-grid project (ACE TAF, 2021b, 2021a).

Example:

There are several finances existing, which provide technical assistance or capacity building support, to ensure an efficient management of the funding the companies raised (i.e. All On Hub, AECF). Creeds, a Solar Home System (SHS) developer established in 2012, won the Nigerian Off-Grid Energy Challenge among others in the SHS category in 2018. In addition to funding, technical assistance by the United States African Development Fund (USADF) and governance support from the impact investment company All On was provided. Through the technical assistance CREEDS was able to develop a financing application. 2021 CREEDS signed the Output-Based Fund agreement with REA under the Nigeria Electrification Project (NEP). The grant CREEDs has received helped to leverage other financial resources for scaling-up (Uzoho, 2018).

Existing tools

FATE - Financial Assessment Tool for Electrification

With MEI’ FATE Tool, project developers, policy makers, and financiers will be able to model and evaluate the economic viability of min-grid investments. The model only displays the most important features, allowing for an easy input of all key data, as well as providing sufficient feedback to fully understand and analyse the economic performance of the target mini-grid project. It allows consideration of up to three different cash-flows, which may reflect three villages with different economic conditions and performances. To increase the scope of scalability, an unlimited number of villages can be considered for each of the three different cash-flows, representing clusters of villages that have the same economic conditions and performances. All cash-flows of the considered sites are consolidated in the Financial Model to display the company’s overall economic performance. By adding the company’s overhead costs and financing conditions, the income statement and balance sheet of the mini-grid investment can be produced and financial indicators like the Project Internal Return Rate (IRR), the Equity IRR, the Net Present Value (NPV) and the Debt Service Coverage Ratio (DSCR) are calculated.

1. download link 1 to tool (Excel file) #
2. download link 2 to user manual# (still under development)
3. Video with guidance# (still under development)

Bibliography