What is Internal Funding?
Internal funding refers to the use of an organization’s existing financial resources to pay for energy efficiency, renewable energy, or other generation projects, rather than seeking external financing. This is often the most simple and direct method for funding projects, and it allows the organization to capture the full financial benefits of energy projects rather than paying a portion to a financing provider. Methods for internal funding include operating or capital budget expenditures, self-funded energy savings performance contracts (ESPCs), capital investment funds, revolving loan funds, and internal carbon pricing.
Internal funding may be a good fit if your organization...
Has funds available or can raise additional funds for energy projects
Is comfortable spending its own funds on energy projects rather than core operations
Wishes to capture the full economic benefit of energy projects, rather than paying back a financing provider
- Cannot seek external financing due to debt limits or other restrictions on financing
Energy projects often provide a very compelling return on investment, in addition to other benefits including reduced emissions, better air quality, and improved reliability of building operations. In an ideal world, every energy project with significant benefits could secure funding through an organization’s standard project approval process. In the real world, however, energy projects must compete with other priorities within an organization for both capital and attention from the management team. That means even a project with excellent financial returns may be rejected in favor of other needs.
External financing is one way to overcome to these barriers. However, there are several innovative internal funding strategies currently in use that can provide a solution without requiring the use of third-party capital. The sections below briefly describe five common approaches for internal funding of energy efficiency, renewable energy, and other generation projects—including a basic description, pros and cons, and additional resources.
For a more detailed primer on internal funding for energy projects, see RILA’s Internal Financing Guide (the guide is focused on the retail sector but has valuable information for all sectors).
1. Operating or Capital Budget Expenditure
The simplest and most direct way to fund energy projects is by using existing capital or operating budgets. Common strategies to streamline this process include (a) empowering individual branches or locations to identify potential upgrades and then use their own operating budgets to fund them and (b) creating an expedited approval process in which energy upgrades take less time to be reviewed and approved as part of capital budgeting. Both of these options require trust and clear lines of communication between the energy and finance teams, but they can be a powerful way to remove red tape. Examples of expedited approval include the Kohls Energy Finance Strategy as well as Hudson Bay and REI.
- Simple strategy that uses existing budgeting processes
- Does not require extensive setup or management costs
- Does not guarantee funding availability for energy projects in future years
- Existing budgeting processes may move slowly and need to be streamlined
2. Self-Funded Energy Performance Contract
Energy savings performance contracts (ESPCs) are one of the most common methods of implementing energy efficiency measures. In an ESPC, the customer partners with an energy service company (ESCO) or contractor to scope, develop, and implement a set of efficiency improvements across one or more facilities. The ESCO often provides upfront energy auditing and assessment to determine which upgrades are available and cost-effective, including the identification of efficiency incentives or rebates. The ESCO then enters into an energy savings performance contract (sometimes called an energy performance contract, or EPC) with the customer in which the ESCO agrees to implement and manage the upgrades. In exchange, the customer makes regular service payments to the ESCO.
While some ESPCs are backed by financing, organizations can choose to pay for the cost of the installation out of pocket. Self-funding eliminates the need to involve a third-party lender/investor, meaning the organization avoids interest payments on financing and time spent arranging financing.
For more information on energy performance contracts (both financed and self-funded), see the full EPC Fact Sheet.
3. Capital Investment Fund
A capital investment fund is a special budget dedicated to financing energy projects across an organization’s portfolio. Capital investment funds are designed to achieve organization-wide energy and carbon reductions while also delivering a net profit, as the cost savings generated by projects are retained in the appropriate operating budget. This approach can incentivize individual building managers to identify energy projects in their facilities as they apply for funding, which helps to foster a competitive environment. Capital investment funds must be replenished regularly (typically annually), as the funds are not repaid as they would be under a revolving loan fund. An example of a well-known capital investment fund is the adidas Group greenENERGY Fund.
Engages facility managers and other stakeholders to identify projects for funding
Demonstrates ongoing commitment to energy performance via recurring capital allocation
Provides dedicated pool of money for projects that can be efficiently managed and tracked
Must be replenished frequently, as savings are not recouped into the fund
- Obtaining buy-in for a recurring capital allocation can be difficult
4. Revolving Loan Fund
Also known as a green revolving fund (GRF), a revolving loan fund (RLF) is a pool of internal capital used to fund multiple rounds of energy projects. Some of the cost savings achieved are used replenish the fund (i.e. “revolved”), thus creating a sustainable funding cycle that can be maintained indefinitely. This differs from the capital investment fund approach, which does not include a revolving component. An RLF may be managed by a single individual or office, or by a committee of stakeholders drawn from throughout the organization. Like capital investment funds, RLFs incentivize individual facility managers and other stakeholders to propose projects for funding. While RLFs are fiscally self-sufficient and do not require replenishment, they can be increased in size over time as performance is demonstrated.
The higher education sector has led the industry on adoption of RLFs, with 79 funds and $111M committed as of 2012. Those numbers are expected to have increased dramatically since 2012. Healthcare facilities and cities have also launched a number of RLFs, and the model has potential in other sectors as well. The Billion Dollar Green Challenge has a variety of resources on RLF development and management, including case studies, implementation guides, and sample documentation.
Replenishes its own funds, creating a long-term mechanism for improving energy performance while prioritizing projects with a high return on investment
Engages facility managers and other stakeholders to identify projects for funding and potentially participate on a management committee
Demonstrates ongoing commitment to energy performance
Provides dedicated pool of money for projects that can be efficiently managed and tracked
Leadership may be hesitant to “lock up” capital in a dedicated fund
- Repaying the fund from project savings means that fewer savings are realized in the operating budget in the short term
5. Internal Carbon Price
Internal carbon pricing is a policy that assigns a cost to the greenhouse gas emissions generated by an organization’s operations. This allows the organization to “internalize” the environmental and social cost of its activities and incentivize lower-emissions strategies. A carbon price is typically structured in one of two ways: (1) A real price (dollars per ton), in which departments, branches, or other subdivisions pay into a fund proportional to the amount of carbon they’ve emitted. The fund is then used to invest in energy efficiency and renewable energy projects that reduce organizational emissions. (2) A price signal (dollars per ton), where the cost of carbon shows up as a line item in the organization’s financials and is used to inform decisions about capital investments, risk management, and strategic planning. As of 2015, there are at least 435 major corporations, including 97 in the U.S. and Canada, that use some form of internal carbon pricing.
Revenues from a carbon price can be used to feed a fund for building upgrades
Creates a structural incentive that pushes the organization toward more efficient, lower-emissions activities
Hedges against the risk of external carbon price regulation at the city, state, regional, or national level
Creates additional accounting and management complexity
Leadership may be hesitant to impose a carbon price
- Best practices are still emerging for carbon pricing--a relatively new practice
Better Buildings Implementation Models
adidas created the greenENERGY Fund to facilitate investments in energy efficiency and renewable energy projects; the company approved funding for 61 projects, investing $10.8 million and achieving a 29% internal rate of return across the project portfolio.
With limited capital funds for energy efficiency, Best Buy established a rolling portfolio-wide lighting retrofit program using maintenance funds, resulting in reduced energy, labor, and lighting replacement costs due to the increased efficiency and life of LEDs.