Solar-as-a-service? Generate Capital wants to sell you infra-as-a-service

A clean energy specialist and a venture capitalist have created a business that is deploying an ‘infrastructure-as-a-service’ strategy similar to that which made residential solar a huge success.

A lot of factors have led to solar energy’s growth, but don’t overlook the power-purchase agreement.

The de-facto mechanism for installing rooftop panels, first popularised more than a decade ago, allows for developers to quickly build small-to-medium-sized projects on a customer’s property. Electricity is sold at a cheap rate back to the host and anything left over to a utility.

Scott Jacobs and Jigar Shah, co-founders of Generate Capital, believe the underlying principles of the power-purchase agreement that powered the solar revolution can be applied to assets across the infrastructure sector.

“Infrastructure-as-a-service,” as Jacobs calls it. “We offer users a service model rather than a capital expense.”

Generate, based in San Francisco, pays upfront for the construction and maintenance of securitised, small-scale energy generation and efficiency projects. It makes money through contracted payments, a power-purchase agreement.

“Most of the people buying electrons are not in the power plant business. They don’t want to have to build, own or operate a power plant,” Jacobs explains, adding that most would also like a lower power bill from their utility.

If the strategy sounds familiar to the solar-as-a-service model that has made residential solar affordable to thousands, consider Shah’s background.

“A fund is a hammer that looks for a nail. We don’t need just one type of nail”

He co-founded SunEdison, once the largest renewable energy company in the world. After leaving in 2008 – before the company’s yieldco-driven growth would lead it to bankruptcy last year – Shah teamed up with Jacobs and a group of clean energy and financial entrepreneurs to launch Generate in 2014.

Then consider Jacobs’ background. A career that began in tech venture capital has shifted to focus on innovation in energy systems.

Jacobs says he met Shah more than a decade ago through a mutual venture capitalist acquaintance. The two stayed in touch over the years. Jacobs says he used Shah as an example of “how to create value in renewable energy” in his work at consulting firm McKinsey.

“He took technology that was 30, 40 years old, very well-proven, and turned it into infrastructure, so that folks like Walmart and Staples could buy electrons cheaper from him than from the utility,” Jacobs says.

Now the two are in business together to deploy the service strategy on a wider range of assets. Recently backed with $200 million from US institutional investors, led by the Alaskan Permanent fund, Generate is preparing to disrupt traditional business models.

‘They want to use it’

It’s sometimes called an offtake agreement or service contract, but most people in the industry know it as the power-purchase agreement. Simply put, it’s the mechanism that makes distributed generation economically viable.

No reasonable investor will finance a distributed generation asset upfront without a legal document saying the user will pay for it over time. “Project developers that are trying to develop these projects are having to rely on a capital expense by the end user. That essentially means they are paying for 20 years’ worth of resources upfront. Not surprisingly, that’s a tough sales pitch,” Jacobs explains.

The US residential solar market has already proved the model can be wildly successful, but whether that translates to different assets is yet to fully be seen.

Generate has financed around $500 million worth of distributed projects in sectors that Jacobs says are “misunderstood, perceived to be risky”. The company invests in “technology-enabled” projects such as solar and battery storage, biomass and wastewater processing and generation. Generate has backed projects from battery storage systems in California to hydrogen-powered fuel cells for fork lifts.

The company is fronting that expense from its own balance sheet. They pay to have the project built and maintained, and the customer pays for the service in installments, usually for around 20 years.

Business-as-a-service is a mindset Jacobs and Shah have brought over from the tech world.

“The traditional Silicon Valley approach to entrepreneurship and innovation is about inventing something new that people want to buy. Well, in energy and resources, people don’t want to buy gear. They want to use it,” Jacobs explains.

However, there are limits to how large infrastructure-as-a-service can go. It’s not a model that can pay for new toll roads or bridges. Those projects are too complex. Generate has zeroed in on a corner of the infrastructure market where there is a “dearth of capital” available for small, tech-driven projects, Jacobs says.

“What we have seen at Generate is the opportunity to do exactly that with a lot of other technologies that are like solar was 10 years ago,” he explains. “Where markets are fragmented, not organised, and where the business model needs to be run by delivering services, not equipment, to the customer.”

Balance-sheet business

Aside from the Alaska Permanent Fund, Jacobs won’t say who has invested in Generate or how much the company has raised. He did offer a hint that Generate Capital has done deals worth around $500 million, including leverage, and Alaska’s $200 million will allow for another half a billion or more.

That equity isn’t going into a fund structure, though. Generate is structured as a balance-sheet business, so investors buy company shares. Jacobs explains the reasoning for this structure as two-fold: flexibility and return expectations.

“A fund is a hammer that looks for a nail. We don’t need just one type of nail,” he says.

First, Jacobs continues, closed-ended funds are an unnatural fit for infrastructure assets that work for decades. Investing this way means losing the freedom to decide when to invest and exit.

“If you take away my discretion around the time I’m buying or selling, you’re taking away a lot of my power to determine the price of entry and exit, and thus the return,” Jacobs says.

Investing through a fund also means Generate must charge a consistent cost of capital – fees, hurdle, carry – and must meet a certain annual return across all assets. The projects the firm is funding are newer technologies that have less certain returns.

“We are constantly optimising our balance sheet, reducing our cost of capital and thus reducing our hurdle rate,” he explains. “As a result, we can offer to many different types of partners the appropriate cost of capital.”

Growing intelligently

Jacobs is mindful of the last time venture capital flirted with energy innovation. To avoid the mistakes of cleantech investors from a decade ago, he says Generate is growing “intelligently”.

The company doesn’t have an open door for any investor to jump on board. Instead, Jacobs says the company is working with partners whose interests and approach to infrastructure aligns with theirs.

“It’s all about building trust,” Jacobs says. “We have to earn the right to keep doing what we said we’d do.”

Generate must continue to prove why its service is needed in the infrastructure market when there are countless ways for investors to deploy capital. The prize, of course, is being able to offer investors the best one. n