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Solar Development Capital: Lessons Learned in Financing Solar Home Systems (March 2007)

Solar Development Capital: Lessons Learned in Financing Solar Home Systems (March 2007)

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Published by IFC Sustainability
Solar Development Capital: Lessons Learned in Financing Solar Home Systems presents findings and lessons learned from an April 2006 evaluation of the Solar Development Capital (SDC) initiative. The evaluation concluded that, in hindsight, lack of capital was only one of a myriad of barriers to the growth of solar photovoltaic (PV) in emerging markets. Innovative financing and grants from institutions such as Global Environment Facility (GEF) and IFC, however, will remain important in building the solar PV industry's capacity to absorb private capital that can propel the industry forward and meet the demand of millions of rural people living without electricity.
Solar Development Capital: Lessons Learned in Financing Solar Home Systems presents findings and lessons learned from an April 2006 evaluation of the Solar Development Capital (SDC) initiative. The evaluation concluded that, in hindsight, lack of capital was only one of a myriad of barriers to the growth of solar photovoltaic (PV) in emerging markets. Innovative financing and grants from institutions such as Global Environment Facility (GEF) and IFC, however, will remain important in building the solar PV industry's capacity to absorb private capital that can propel the industry forward and meet the demand of millions of rural people living without electricity.

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Published by: IFC Sustainability on Jun 28, 2009
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 Measuring development results in IFC 
Solar Development Capital: LessonsLearned in Financing Solar Home Systems
In the late 1990s the World Bank Group together with a number o US-based charitable oun-dations initiated an ambitious new nancing and advisory services vehicle aimed at developing world solar photovoltaic (PV) businesses. Called Solar Development Group (SDG), it had twoseparate but interrelated components with common management oversight. SDG consisted o:(i) a not-or-prot Solar Development Foundation (SDF) unded by the Bank Group’s Devel-opment Grant Facility and a number o charitable oundations; and (ii) a private equity undinvestment vehicle called Solar Development Capital (SDC). The Global Environment Facil-ity (GEF) was requested by IFC to contribute subordinated risk capital co-nancing to SDC.Together the two components o SDG were expected to constitute a groundbreaking initiativeto expand use o solar photovoltaic (PV) by rural people lacking electrical service in developingcountries. The SDC private equity und established in 2001 through this joint eort was ulti-mately terminated in 2004. Although the SDC portion o the SDG project ailed to appreciablboost rural PV solar industry nancing in emerging markets, the experiences gained generatedmany lessons that can help to inorm uture eorts. This issue o the Monitor presents ndingsand lessons learned rom an April 2006 evaluation o the SDC initiative. The evaluation con-cluded that, in hindsight, lack o capital was only one o a myriad o barriers to the growth o PV in emerging markets. Innovative nancing and grants rom institutions such as GEF and IFC,however, will remain important in building the solar PV industry’s capacity to absorb privatecapital that can propel the industry orward and meet the demand o millions o rural peopleliving without electricity.
 Anticipating a major technological breakthrough insolar PV, industry actors in the 1990s had begun to ex-plore expansion o this technology to meet the energy needs o the nearly two billion people living withoutelectricity in the developing world. These people live inareas too remote, poor, and sparsely populated to sup-port the inrastructure investments needed to expandconventional electrical grids. A joint initiative between the World Bank Grouptogether with a number o US-based charitable oun-dations sought to catalyze an “order o magnitude” im-pact in the growth o PV businesses and dynamic PV markets in developing countries through a unique new nancing and technical assistance vehicle called SDG.The SDG initiative relied on IFC which mobilizedGEF grant nancing alongside private, government in-vestment bodies, and institutional capital in SDG’s So-lar Development Capital (SDC) arm, a US$32 millionprivate equity und. Several widely shared assumptionssupported the approach behind this equity und:
PV performance and prices would improve as mass
production o cells and modules expanded, increas-ing the competitiveness o the technology.
Monitor shares key fndings rom in-depth reviews o IFC programs and projects conducted by external evaluators. Thereviews address the relevance, efciency, eectiveness and sustainability o these programs. For more inormation aboutthe evaluation o IFC programs visit http://www.ic.org/results.
ISSUE NO. 13, APRIL 2007
The market for PV systems, including rural households,
 was a sucient basis or a growing, protable businessin many parts o the world, thus, justiying a global ap-proach.
Potential returns on investment and scale of investments
 were sucient to justiy a proessional und managerand und governance structure.The IFC/GEF SDC portion o the SDG project had twoprimary objectives: accelerate use o PV solar home sys-tems and contribute to lowering carbon dioxide emissionsin regions or intended investments. SDC was specically to (a) act as a showcase or the PV solar home system in-dustry, (b) attract capital, and (c) demonstrate that un-electried markets oered the potential or commercialinvestment, given that lack o capital is one o the mainactors holding back massive growth. SDC was positionedto be at the oreront o building rural, o-grid PV solarhome system markets by engaging commercial capital toplay a catalytic role in growing the PV industry in emerg-ing markets.In 2006 Enterprising Solutions Global Consultingundertook an evaluation o SDC rom startup throughdisbandment. Methodology consisted primarily o a desk audit and stakeholder interviews with one site visit to Ke-nya. Stakeholders included ormer Board members, in-vestment ocers, investees, and sector specialists. Review o key SDC documents ranged rom Board minutes andIFC project records to annual and evaluation reports andpublications on international PV experiences.
In the mid-1990s, PV market undamentals seemed prom-ising and industry experts discussed the potential “com-moditization” o the industry, creating a market potentialin the mind o SDC project ormulators that was validat-ed by an independent easibility study based on limitedmarket intelligence, much o it extrapolated rom sales inindustrialized countries. Market research or SDG thatguided SDC’s establishment overestimated the growth po-tential and potential nancial returns o the PV sector andunderestimated the myriad actors required to achieve amarket breakthrough and rapid scale-up. Furthermore, aproject ormulation process driven more by the needs o the project sponsors than those o potential recipient rmsin the developing country market, coupled with an overly complicated implementation structure and poor marketundamentals contributed to less than desirable results.However, the “disconnect” between project designand market reality ultimately led to disbursement o only US$650,000 o SDC’s total committed capital o US$28.75 million to three companies in Kenya, Indone-sia, and Bolivia between 2001 and 2004. The Kenyan in-vestee declared bankruptcy in early 2005. The Indonesianinvestment was terminated prematurely due to cancella-tion o a parallel World Bank/GEF unded PV solar homesystems subsidy program to Indonesia. The Bolivian ven-ture continues to grow, although with somewhat limitedimpact to date on rural SHS delivery. Bolivia is also now being supported by a World Bank/GEF solar PV program which was not in place at the time that the SDC invest-ment was made.SDC’s investment guidelines were not always appro-priate or the unique situation oten aced by the small andmedium enterprises (SMEs) characteristic o the rural, o-grid solar PV sector—requently sole proprietorships lack-ing audited nancial statements or considered too small orinvestment. In addition, limited sectoral expertise amongSDC’s investment ocers and their physical distance romthe investments impacted the guidance that SDC couldoer investees. Both actors limited SDC’s ability to iden-tiy deals and support investments once made. Overall,SDC’s achievements related to accelerating the use o PV solar home systems and indirect environmental results re-lated to the reduction o carbon dioxide emissions werevery disappointing compared with original expectations.
Rural PV service providers.
These tend to be young,high-risk, low-margin rms needing patient capital withlow-return expectations. They typically lack managementexpertise, systems or managing growth, market develop-ment capacity, and customer service ocus and are sensitiveto external actors, such as economic downturns, increaseddemand in other markets, and capacity o nancinginstitutions to provide adequate liquidity to grow a market.Protability is oten elusive in the rural solar home systemindustry, due to high system prices in emerging marketsand high distribution costs, given low population densities.SDC’s private equity structure was also ill suited to ad-dressing the needs o small low margin and inexperiencedPV rms operating in rural settings. Sustainable delivery o PV services appears to require strong relationships amongkey stakeholders—government, multilateral agencies, lo-cal business networks, NGOs, and so on—to create anenabling environment or successul rural PV solar homesystems delivery. Many practitioners now believe thatsubsidies are necessary at an early stage to compensate orthe high upront costs o developing protable distribu-tion networks in rural areas. Only a combination o theseactors can result in a market that generates sucient de-mand or PV services to support the growth o protablePV businesses in rural areas.
Issue No.13, April 2007 MONITOR: Measuring development results in IFC
Project formulation.
SDC’s narrow ocus on “PV solarhome system electrication in rural, o-grid areas, tar-geting low-income people, with service provided throughSMEs” and high expected rates o return was too ambi-tious, considering the resources ultimately available to theproject, and more appropriate or a more mature or aster-growing market than PV solar. Few deals met both SDC’snonnancial and nancial criteria. SDC’s ten-year xedlie required management to seek investments promisingrelatively rapid exits; whereas the PV solar home systemsindustry appears to require long-term patient capital. Theamily-owned nature o small businesses in emerging mar-kets and low rm valuations made it similarly dicult toidentiy potential investees. Moreover, capital markets inemerging countries tend to be very small, minimizing theopportunities or exit. In addition, similar initiatives tar-geting solar PV in promising markets, also sponsored by IFC and GEF, and eaturing more o a subsidized conces-sional nance approach and utilizing no IFC capital hadalready been launched (e.g., PVMTI). Pursuing the SDCproject would have been more justiable ollowing a moreextended trial period with such other complementary solarPV nancing programs. Perhaps SDC then could havebeen justied or its nancing structure modied on thebasis o the success o a similar, smaller-scale initiative.
Structure and implementation.
Although the projectbeneted rom the diverse experience o the managementteam—consisting o a nonprot U.S. environmental undmanager, a U.S. solar PV consulting rm, and a Euro-pean und management company—issues o distance,culture, organizational style, language, and ownership o SDC and o the managing company, overlaid by a com-plex stang arrangement and undamental questions con-cerning its relationship to SDF, complicated SDC opera-tions. Nevertheless, considering its complex structure, theorganization worked surprisingly well and operated ru-gally, demonstrating a high degree o commitment andproessionalism. Although SDC was very successul in mobilizing asubstantial capital base rom a range o investors—secur-ing commitments totaling $28.75 million o a targeted$32 million—managing ten shareholders rom across thedevelopment/nance spectrum also proved challenging.Disagreements among shareholders led to stalemate andultimately early termination o SDC.
The SDC experiment oers many lessons related to devel-opment o the PV solar industry and to any project devel-opment process, including investment strategy and undmanagement:
The PV Solar Home Systems Market
• For initiatives intended to meet standard commercial
objectives, no substitute exists or rigorous market anal-ysis. It allows or planning, enables the relevant entity toset realistic internal rates o return, determine appropri-ate payback periods, and estimate customer uptake andlong-term sustainability. Although this kind o analysis will oten be too expensive or use in small transactions,it would be invaluable or larger transactions or a port-olio o small transactions. Eective mechanisms oughtto be established to implement this process.
Protability for the industry may take years to improve
unless the challenges o distribution and client nanc-ing are resolved, even with technological breakthroughsand dramatic price declines in PV panel production.Considering the current state and cost o the technol-ogy which ahs been rising rather than alling, PV solarhome system delivery can only be protable given (a)sucient population density and purchasing power, andlittle likelihood o medium term grid electrication, (b)a supportive tax regime (i.e., no excessive import dutiesor sales taxes), and (c) the presence o appropriate con-sumer nancing options. In early stage market devel-opment, existence o ecient and appropriate subsidies(e.g., sustainable and perormance based) generally con-tributes to an initially acceptable level o protability. A stable economic environment (limited business, politi-cal, and currency risk) supports long-term protability.Nevertheless, PV rms are quite vulnerable to externalactors such as equipment supply and pricing trends.
Provision of efcient maintenance services is also criti
-cal to success. Protable PV solar home systems haveemphasized maintenance in their business model. PV practitioners estimate that one-ourth to one-third o the two to three million solar home systems installed inthe world no longer unction.
End-user nancing is, in many cases, the only way for
low-income customers to pay or the oten high uprontcosts o PV systems. But customers must be able to a-ord monthly payments or two to three years— whichis still not the case in many countries. Moreover, end-user nancing cannot always help with low product de-mand and awareness or inadequate development o thenancial sector. Credit schemes and collection methodsmust be fexible enough to allow access to credit or thepoor and help ensure high repayment rates. The strongcommitment o any end-user nancier and its involve-ment with the vendor in program conception is essen-tial. The number o parties involved should be limitedto reduce the chances o ailure.
MONITOR: Measuring development results in IFC Issue No.13, April 2007

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