Solar Financing in India - Part 1
Setting the context - Understanding the retail solar ecosystem
“Keep the goal highest, so high that you can’t reach it … because reaching the goal is not the goal … STRIVING to reach is the goal … that’s when you grow day by day, week by week.”
For the last ten years, I have been toying with this heady goal that why can’t we power every home and every business in India with rooftop solar. As naïve as it may sound - we have enough Sun, we have plenty of demand, we have the technology and we have the capital – then why can’t it be done? On another note, why hasn’t it been done? So, I took a stab or two to solve this problem.
In the journey, I learnt so much about the nuances of business, of policy and how the game works. I find myself privileged that many early-stage founders and VCs reach out to me to ask for help on retail solar financing. The intent of this writing is to explain the game as I understand it and as I played it – so that they may play it better.
As for some background, academically, I have degrees in engineering and finance but my true learnings in both these subjects have come through practical experiences. I ran a solar installation company from 2015 to 2018 and we pioneered residential and small commercial installations in urban India. Very soon, I realised that, on its own, installation wasn’t a scalable business, and I continue to believe that.
Solar was expensive hence innovative financing seemed like a good solution. Towards the end of 2018, I found myself pitching to lenders – saying, “if you can finance a new car made of glass and metal that loses some its value the moment its driven out of the dealership, why can’t you finance solar for the same customer, for the same amount, which has a longer life and generates income?” With constant push backs from over twenty lenders, I decided to do it myself.
In 2018, we pivoted to a financial services company, a Reserve Bank of India registered Non Banking Finance Company (NBFC) – We got the necessary regulatory approvals, we raised capital, built an innovative loan product, a solid distribution network, fintech partnerships and then Covid struck. In the months following Covid, I took time to reflect on the industry and the challenges we face. The problems seemed systemic and a complex matrix of many little things. As I take a break from the hustle, I hope you can learn from some of my experiences.
I come from a certain background hence write with a certain bias. As a first-generation entrepreneur, I got into this game knowing well that my lens would be that of consumer first. The words that resonate are consumer, finance, technology, service, brand etc. However, the solar business is anything but that … it’s far more brick & mortar and regulations driven than I originally envisaged. I do not understand and hence never involved myself with manufacturing, subsidies, government projects and tenders. I stayed away from anything that involved an establishment for I never had any experience working with them. The traditional power businesses operate with a high degree of overlap with these regulations. Even the largest and most successful renewable companies in India continue to be large infra plays rather than consumer plays. The answers to retail solar maybe found in the parts of the ecosystem that I overlooked but I am honest in my admission that its not the side of business I understood or aspired for as an entrepreneur. Many of the start-up founders I speak to have similar backgrounds as me – Their ambition is to build a company akin to an Uber and not a large regulated Infra company.
Team Solar vs Team Lending
Solar is a new industry and lending is one of the oldest businesses in the history of mankind. The folks I have seen most interested in solving the solar financing problem are the solar ones. For them, this is such a simple intervention that its frustrating that lenders don’t understand.
On the other side, the lenders appreciate clean energy but they are naturally more conservative. In a very rudimentary breakdown, the traditional lenders in India think of four buckets - home loan, car loan, business loan and personal loan. Each of these buckets is tried and tested with clear risk reward ratios. Throwing solar in the fray can be confusing because retail solar assets don’t easily fit in any of those buckets.
The conversation in this essay centres around last mile financing for residential and SME businesses, more as a loan product than as a lease or a PPA. Any form of lending eventually comes down to the risk reward ratio. Lenders have to manage the size of the loan book while maintaining its quality.
Before anything else, let’s first look at how lending works.
To put it very simply, a lender’s work is divided into three activities: Give loans (Money out), Raise money to give those loans (Money in) and run the operations in such a way that the business is scalable, sustainable and profitable (Operations). In these three buckets, many points are interconnected. While I try my best to explain, it may still take you a bit of effort to connect the dots and understand the linkages.
Here’s the good news: the mechanics of how a homeowner or business consumes solar and how anything gets financed is broadly the same everywhere in the world, hence my hope is that once you understand the construct, you would have the tools that could help you across asset classes and across geographies.
This essay is divided into 5 parts:
Part 1: Introduction
Setting the context
Understanding the retail solar ecosystem
Part 2: Money Out – In this part, I will discuss the asset side of the lending business
Who and where are your customers?
What are the features of a loan product? Interest rates, fees, tenor, collateral etc.
Who are the other lenders in the market?
Part 3: Money In – here, I will discuss the liabilities side of the lending business
Raising equity – Why would or would not a VC look at this space?
Raising debt – You must take loans to give loans … How lenders look at you?
How accessible is foreign capital?
Part 4: Managing operations – Operations of a lending business
Customer acquisition cost - Perhaps the hardest bit of work in solar
How much or how little does Fintech help in this business?
Taking care of your bad loans – How to avoid them, contractual enforcement, repossession, resale
Part 5: Other considerations for founders
Successful business models that seem to be working in solar financing
Cleantech opportunities outside of solar
Fundraising for cleantech start-ups – ESG, Impact Investors, Accelerators etc.
Return on Assets (RoA) Tree
The above structure comes from the way a lender thinks - which in their parlance would be called a RoA tree. All numbers below are in %.
A) What interest rate + fees will I charge my borrower?
B) What is the cost at which I will borrow funds?
C) Let’s call A minus B as “Spread”
D) What are my operating costs (acquiring customers, deploying technology)?
E) What are my credit costs (losses associated with bad loans)?
F) C minus D and E = This is effective pre-tax Return on Assets.
You multiply the Return on Assets with a degree to which you can leverage your balance sheet i.e. how much debt can you take on your equity and then what you get is Return on Equity.
This is a very simplistic way of looking at lending but for the purpose of this essay, it should suffice.
The Retail Solar Playbook in India
The fundamentals of retail solar are theoretically very strong. We have a lot of sun, we have a lot of power needs – 300m homes, millions of SMEs that are the true engine behind our economy. Power as % of input cost is very high in many industries. Rooftop solar has been around for ten years and is well understood. Most SMEs and homeowners know at least one person who has gone solar.
Electricity in India is a concurrent subject on the constitution which means both state and the centre have powers. Here are the key stakeholders:
Governments – Ministries at the centre and state – they drive policy
Central and State Electricity Regulatory Commissions – amongst other things, they decide the tariff and are quasi - judicial bodies at national and regional level respectively
State Nodal Agencies – they promote and execute renewable energy development plans within the state
DISCOMs (Distribution companies) – They have the last mile connect with the customer, they take your meter readings and send you an electricity bill
India has 36 states and union territories, most have their own electricity regulatory commissions and state nodal agencies, and there are over 60 DISCOMs. With so many actors the probability of rules changing is very high.
I understood very early that retail solar is a hyperlocal business. We focused only in Delhi and Mumbai for our urban projects. Here’s the interesting bit, everyone talks about Delhi National Capital Region (NCR) as one giant megalopolis but from a solar perspective – Delhi, Noida, Gurgaon, Faridabad, Ghaziabad are in different states and have their own DISCOMs and rules. Sometimes within the state the there are multiple DISCOMs. Each of these states have different electricity rules, different electricity tariffs and different rules for solar.
Another example - Maharashtra and Tamil Nadu are two great industrial states – All of Tamil Nadu has one DISCOM, while all of Maharashtra has one DISCOM but Mumbai (capital of Maharashtra) has four DISCOMs. I hope I have given enough for you to think about standardization of regulations – there are none.
Ease of doing business and Consumer behaviour
India is a land of amazing culture and diversity – many of these states speak different languages and have their own culture of efficiency and operations. India then is a land of 36 unique cultures each with a very different business environment (true for solar as well).
The buying behaviour of solar varies from state to state. Some people buy to save the environment, some buy because their neighbour did so, some do because state government is giving an incentive but all buy because it makes economic sense.
I must say that over the years the market awareness for solar has increased tremendously. Poor air quality in major cities, falling costs, political will, have all played their part in this very positive change.
Life of an EPC
Someone once told me selling residential solar is like selling a modular kitchen – each home is different, every person’s choice of colours, wood, glass, granite is different – how do scale such a service business?
We are a land of engineers – we have way too many Engineering, Procurement and Construction (EPC) companies. They are easy to start but very hard to run. EPC is a fundamentally difficult business to scale. Someone once told me “you can sell 10 on hustle and 20 on charm but after getting to a critical mass its incredibly difficult to grow”.
Presumably you have reached a point where the market likes you and you are getting orders, but you will be still fighting with heavy competition for margins. I have seen folks work at 0% – 15% margin.
0% because all of us have done at least one project, hoping that we will get a reference from it later … That day never comes, if it does, its perhaps too late and the next customer asks for a discount because he / she can provide more references later.
Presuming you have magical procurement and you have solved for the margin issue – you then realise that, the entire EPC game is one of managing net working capital.
Most brick & mortar entrepreneurs don’t get this at first – cash is king. Once your working capital dries up, it doesn’t matter what kind of revenue pipeline or margins you have. A team member will quit if you don’t meet payroll.
Project or Product
It's hard to survive as an EPC because you are selling a project - a completely non standardized set of panels, inverters, cables and junction boxes - If there are 10 homes in a row – there is a good chance, each home would have a different solar system in terms of look and design. When your product is not standardized – each and every sale requires new design, new analysis – it’s an inefficient process.
In my experience, mapping softwares are not that accurate hence for designing the system, one has to visit the site. Our team had seen 700 unique rooftops across India. I used to joke to the team that at least in suburban Mumbai, I can become a real estate broker because we have visited so many of them that we have memorized building names.
Loooong Sales Cycle
The sales cycle of solar are gruelling … Someone shows interest, you meet them once, twice – then radio silence for a few weeks, months, years (I am not exaggerating) – then they resurface, but this time with multiple quotes and then the price war begins … If you win, the excitement of closing the deal quickly fades away when you think of your margins.
All the same
EPC in the retail space is highly undifferentiated business –
Most teams are equally good or bad at engineering design
We all procure from the same dealers, distributors and OEMs
As you scale, you realise that having a large construction team is not possible, so you outsource (subcontract) - that comes with its own perils
We all use the same softwares to come up with energy forecasts
This bit of differentiation is a hard pill to swallow because we all believe we are unique (and rightfully so) – but when you hit the VCs, they will mince no words to tell you that you that there is no moat in your business and you are a me-too player. That’s why there have been so few early-stage VC deals in retail solar EPC space and in general, the mortality rate of small solar EPCs is very high.
Equipment quality and performance
Quality of equipment is a huge concern – there are many OEMs in the market, who do you pick and on what basis. Have you visited their plants? Have you seen their manufacturing process or bill of materials? My work at PVEL is making me realize the importance of reliability testing of solar equipment on project cashflows.
The global solar market is extremely competitive - manufacturers are fighting for thin margins and some have decided to move away from the industry. If the manufacturer is not around, who will service those warranties in case the equipment malfunctions? In any case, claiming warranties from a manufacturer is a complicated process.
Have you seen assets perform long enough in the field? Speaking of diversity - we also have different weather conditions, how do certain equipment work better in the cold and dry vs hot and humid climate. How robust are these assets in terms of power generation, when there is smog in Delhi winter or a cyclone in Chennai?
Is solar on a home or a business really a need?
Too many regulations that differ from place to place
Too many service providers with little differentiation
It’s a project, not a product - No standardization
Margins are thin
Sales cycles are long
Limited history of equipment quality, reliability and performance
Given the above, it is structurally hard to scale retail solar … but its not impossible. Nothing is impossible.
In part 5 of the essay, I will share some of the business models, I have noticed that seem to be mitigating many of these challenges and scaling well.
In the next part, we will discuss the asset side of the balance sheet i.e. giving loans.