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Q&A: Evaluating Investment Risks in Residential Solar Private Equity Deals

6 Min Read

Meet Our Expert

Robyn Kenkel is the VP of Asset Management and Business Development at Spruce Power and Primary Consultant for HHFR Enterprises. Previously, she served as Senior Director and Head of Counterparty Risk at residential financing company Solar Mosaic. She also was President of Residential for multi-state contractor Sunfinity Renewable Energy. Before that, Robyn served in various operations and sales roles at residential solar company Sunnova Energy Corp., including as General Manager of the Southwest Region and Strategic Director. In this interview, Robyn draws on her 10+ years of experience in the residential solar industry to provide investment tips for private equity.

Question #1: What is the Market Outlook for Investing Private Equity in Solar Energy?

The residential solar loan industry is grappling with higher-interest loans and higher dealer fees. As financing costs go up, sales organizations are adapting strategies away from low-APR options available during much of the COVID-19 pandemic. Less attractive payment options make it more difficult for sales agents to show customers the same savings value as before. Contractors and sales organizations need to sharpen their pencils more so now than ever before.

In recent months, leases and power purchase agreements (PPAs) have risen in popularity. This financing option allows customers flexibility and savings with no upfront payment, but may cause residential solar companies to assume additional risks as the process for milestone payments is typically much more stringent than those of loan providers.

Companies that assumed sales or pipeline risk in the past several years will likely see challenges in managing their financials, and we may see a wave of bankruptcies. Many, if not all of the finance companies have pulled back pre-construction payment milestones, as the cost of capital has become much higher, and projects are taking longer to complete with supply chain constraints. I think we will see a normalization of volumes, and much of the fat will be trimmed off with consumer credit underwriting tightening as the economic situation continues to progress. The slight market drop-off is not expected to be substantial, however.

Financers in the residential solar industry are primarily focused on maintaining the status quo rather than growing sales volumes. The industry will likely continue to see more consolidation as solar mergers and acquisition activities continue, including consolidation among companies. Plus, as public companies begin to dedicate more efforts toward ESG initiatives, renewable energy in private equity may gain even more traction.

Question #2: What Should PE Firms Know About Residential Solar Sales Structures?

Sales structure is a critical component of a residential solar company’s business model. When evaluating solar, private equity firms should consider the sales structure and how it impacts the company’s customer experience and profitability.

There are three sales structures in the residential solar industry: 

  • 100% dealer model: Contractor partners witha third-party sales company, or multiple sales organizations that have their own branding and platforms, which conduct sales for the installer with a set EPC price agreement in place.
  • 100% in-house mode: A contractor conducts sales in-house with complete internal staffing, which can often be expensive.
  • Hybrid model: An installer retains a small internal sales team and uses some third-party sales organizations to supplement volume.

If a residential solar company uses a 100% dealer model utilizing third-party salespeople, it should trigger PE firms to ask additional questions. Many third-party sales companies attract talent with alluring branding and lifestyle promises, leading their representatives to chase numbers without focusing on a quality customer experience. It is integral for salespeople to adequately educate customers about solar, make reliable promises and provide a positive sales experience.

PE firms should request information about how sales representatives are trained, how they interact with customers and what they promise customers, such as extra services through bundle deals. Salespeople who are unable to follow through on sales with premium customer service, quality products and trustworthy contractors can harm the installer’s reputation.

Plus, firms evaluating private equity solar energy deals should also be aware of an installer’s “redline”—the cost that it takes to procure the equipment, complete engineering and design and construct the project. Sometimes, third-party salespeople sell bad deals that compress margins or lose money.

Installers with in-house teams are not automatically a better option. While these in-house teams have control over their brand and the customer experience, PE firms should still inquire about the spend for marketing which is predominantly through purchasing customer leads from an outside vendor or through self-generation from a call center, which has its own set of compliance regulations. This model can be costly, so it is important that the contractor have a good grasp on their financials and their overall cost stack.

Question #3: Is It Worth Investing in Smaller Residential Solar Installers?

The solar industry includes several large players that take up significant market share, including leading installer/financier Sunrun.

Established local and multiregional players in residential solar have an opportunity to grow in today’s market. This is especially true as some larger players move into new markets. Plus, local solar companies are often the ones who intervene and remediate bad situations caused by over-promising and under-performing salespeople from out of state companies or sales organizations.

PE firms that invest in smaller residential solar companies should evaluate the growth strategy. As long as these companies keep controls in place, they can easily expand on their momentum in a smart way. Firms should be wary of companies that take an opportunistic approach to expansion, which could include moving into too many markets at once using subcontracted labor with little controls and/or offering low redlines in order to attract sales talent.

Question #4: What Investment Red Flags Should PE Firms Look For?

There are a variety of red flags investors should look for in residential solar companies. Red flags can appear in a company’s cashflow structure, business model and customer service experience, among other areas.

One of the largest red flags is solar companies who give sales contractors >50% upfront payment upon contract signings. We are now seeing contractors attempt to circumvent stricter consumer credit requirements implemented by finance companies in order to gain market share by creating their own funds, which requires in-depth expertise. With finance companies rolling back upfront payment terms to conserve high-priced debt, installers may still continue to pay their sales team upfront to continue finding new customers as a way to keep sales teams from jumping to a new installer. This can negatively affect an installer’s cashflow and ability to install projects, sometimes resulting in disaster.

PE firms should also inquire about bundle deals offered by installers, which means adding additional products and services with solar panels—such as roof replacement before solar installation. Some installers recommend products and services but are unable to follow through on their promises, resulting in negative reputational impact and lost customers for the installer. Firms should check whether installers have strong existing relationships with contractors to support bundle deals, such as partnerships with roofers and suppliers.

Additionally, installers that have a large backlog of orders should serve as a red flag for PE firms. This may contribute to an inflated valuation of the company, considering many of these deals may get canceled, delayed or experience other problems, like permitting. On the same note, companies who fail to install a majority of their pipeline within 60 days of contract signing should be a red flag, even in rural areas where it may be harder to travel. If the company has a large backlog of projects that have been installed and not interconnected (or granted Permission to Operate from the utility), this is another major red flag for the operational controls and should be investigated.

There are several other red flags to consider, including: 

  • No CRM system: : Multi-region or multi-state company still using spreadsheets to manage operations versus a customer relationship management (CRM) system.
  • Poor front-end experience: Large companies that are failing to effectively manage the front-end customer experience with proposal tools that integrate financing options.
  • Poor online reputation: Contractors with very bad online reviews should be an indication of business practices. Dive into what customers are saying and why.
  • Buying leads: Contractors who are spending a lot of money on sales commissions, marketing and buying leads, which could indicate problems for overall financial health.
  • Financial risk: Over-stretched liabilities, such as revolving credit lines to cover equipment or payroll needs.
  • Compressed margins: Companies offering a redline (or EPC cost) to sales organizations less than $2.25/watt is problematic and can eat into overall margin when things get off the rails.

Question #5: Should I Seek Advisors for a Solar Investment Thesis?

Residential solar can be a nuanced industry, especially for investors not already familiar in the space. Advisors with experience in the solar industry can provide substantial value to firms evaluating potential solar private equity deals.

For example, some executives offer extreme valuations that do not accurately match the company’s worth. An advisor can help parse through the numbers. Advisors can also help analyze the value of company actions, such as whether the company has developed an effective software stack—a costly investment with not many alternative, ready-to-go options currently on the market.

Advisors can provide additional insights, such as: 

  • How installers are managing their pipeline, including labor 
  • How installers are viewing new markets 
  • Whether operational workflows and controls are effective 

Finding relevant, experienced and trustworthy advisors requires time and research. Partnering with Apex Leaders can help you make an investment decision quicker with confidence. Our team connects PE firms with precise-fit partners with residential solar expertise.

Explore Residential Solar in Private Equity for Your Firm’s Investment Future

Move forward swiftly with help from the experts at Apex Leaders. When evaluating investments in residential solar, private equity firms can rest assured with custom-recruited advisors. Connect with us to get started.