Closed End Funds
February 16, 2012
By Gordon Murray
Now that you have a long-term off-take agreement and a secure fibre supply, all that remains is to build your plant.
Now that you have a long-term off-take agreement and a secure fibre supply, all that remains is to build your plant. And that should be easy if you can just raise enough money, yet arranging sufficient financing can be difficult.
Traditional banks won’t lend for bioenergy projects because they don’t understand them, are averse to risk and won’t finance startups. They want to see at least three years’ worth of profitable financial statements before lending and often require project developers to put in as much of their own cash as they want to borrow from the bank. They also usually require more security than the assets being financed, meaning that the borrower has to sign a personal guarantee and put up his/her home for security.
AN ALTERNATIVE TO FINANCING
Thanks to WPAC associate member Ulrich Hainzl KG a new alternative to bank financing is now available: the closed end fund (or CEF).
A CEF is like a mutual fund where the capital of hundreds or thousands of investors is pooled and invested in assets. But unlike a mutual fund, for each CEF, the amount of capital raised is limited to the amount required for each project, and the term of each project is finite. Once the capital has been raised, the fund is closed for the term of the project. The return on investment is derived from profits earned by the project plus the proceeds received when the project is sold at the end of the CEF’s term.
CEFs are used for investing in real estate, shipping, aircraft and many other related market segments, and a pellet plant would be an ideal project for CEF financing.
Founded 15 years ago and based in Hamburg, Germany, HBI GmbH is a financial services company and CEF specialist which has developed projects, mediated in negotiations and invested several billion euros for its clients.
Yvonne Büttner, one of the managing directors of HBI, said that the company primarily acts as a designing house for private and public placements. “We provide project developers and product providers with customized concepts for the realization of large investment projects, which we then accompany from the first thoughts at the “green table,” on to their implementation, to their operation and finally to the fund’s liquidation.”
HBI GmbH’s current ambition is to design funds to be invested in Canadian renewable energy projects and this presents a serious opportunity for Canadian pellet producers and other bioenergy-related project developers.
LIFE CYCLE OF A FUND
Generally, there are six steps in the life cycle of a CEF:
A project developer prepares a convincing business plan demonstrating attractive and safe returns and presents it to HBI. As long as it has a secure fibre supply, a long-term take-off agreement with investment-grade counterparty and a highly qualified management team, the project is accepted.
The capital requirements – construction, start-up costs and working capital – are determined and the CEF is structured as a limited partnership with investors as the limited partners and the project developer as the general partner. The project developer is the outward face of the project, while the limited partners remain behind the scenes as the actual project owners.
There are two different models:
- The project developer acts as a long-term manager and operator of the plant and pays a fixed annual rent to the CEF for the duration of the CEF. The rent could be temporarily lowered until the project begins to make a profit, for example, after five years.
- The CEF provides for the project developer to be paid a management fee, while the profits up to the hurdle rate are paid to the investors. Any profits exceeding the hurdle rate are generally split between the project developer and the investors and the CEF term is set, usually from six to 12 years. As well, the CEF may provide for the project developer to buy out the project at the end of the term for a predetermined amount, or for the project to be sold to a third party. HBI seeks regulatory authorization to distribute shares, and markets the CEF shares to private investors, which takes between nine and 18 months.
The project is constructed, which must be assured by an EPCM (engineering, procurement and construction management) contract with an investment-grade counterparty. This ensures that the project will operate as intended and not go over
The project developer operates the project for the term of the CEF, reporting to a board consisting of limited partners.
Finally, the project is sold at the end of the CEF term. The return on investment is derived from the profits generated during the CEF term, plus the proceeds received upon the final sale of the project.
Canadian bioenergy project developers should seriously consider CEFs when deciding how to finance their projects. CEF financing is an attractive alternative to traditional bank financing, especially for talented management teams that have great projects, but lack sufficient financial resources to meet the banks’ security demands.
Gordon Murray is executive director of the Wood Pellet Association of Canada. He encourages all those who want to support and benefit from the growth of the Canadian wood pellet industry to join. Gordon welcomes all comments and can be contacted by telephone at 250-837-8821 or by e-mail at firstname.lastname@example.org.
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