Renewable project sales: Established tactics and emerging trends
Negotiations around sales of renewable energy projects follow predictable patterns. That said, there are several emerging new trends in the M&A market in the United States for such projects.
Laying the foundation
Anyone already familiar with such projects should skip to the next section.
Renewable energy projects have three distinct phases: development, construction, and operation. North American renewable energy projects usually change hands either during the development stage or after they are in operation, although mid-construction sales are becoming more common.
During the development phase, a project goes from a budding idea in a developer’s brain to a bundle of legal rights and data sufficient to construct the project. There are two core rights without which a project cannot exist: land rights and grid interconnection rights. There are additional rights, reports and studies that vary based on location and that add certainty and value to a project, such as tax abatements, permits, zoning, wind or solar resource reports, geotechnical studies and transmission studies. And arguably the best way for a developer to increase the value of her project is to find an offtaker.
During the construction phase, a renewable energy project goes from being a bundle of legal rights to a built project, with commencement of construction (notice to proceed) and commercial operation respectively bookending the construction phase. The operational phase begins at commercial operation and lasts as long as the project continues to function economically.
Developers use personal and corporate debt and equity to fund initial development efforts. Once a development project has advanced enough to require credit support for interconnection, offtake or equipment supply, the developer may sell the project to a better-capitalized developer or finance the credit support requirements with additional corporate debt and equity or non-recourse debt if available. The most significant capital outlay for a project comes during construction and, for utility-scale projects, it typically takes the form of construction and bridge loans that are paid off or convert to term debt once construction is complete and tax equity has funded.
As a project moves from being an intangible concept to a tangible asset, the risk that the project will not materialize is reduced. The rewards of ownership become increasingly quantifiable. To drive up the purchase price, a seller tries to portray its renewable energy project as being as close to “shovel-ready” as is credible. Potential buyers will portray the same project as being underdeveloped and risky. If the bid-ask spread is narrow enough and there is an agreed theory of the transaction, the project will trade. There might be an exclusivity agreement or a letter of intent as a precursor to the purchase and sale agreement, and there may be a development services agreement accompanying the purchase and sale agreement.
How much money will change hands, and when, is the crux of the trade.
Some purchase and sale agreements have a simultaneous signing and closing, while others have an interim period during which certain conditions precedent must be satisfied. Signing and closing can occur anytime during the development phase. Signing consideration is usually tantamount to a partial return of capital, reimbursing some of the developer’s expenses to date, and closing consideration is typically an agreed-upon amount that reflects the value of the project at that particular stage of development. The less developed a project is at closing, the larger the percentage of the purchase price the buyer will withhold for post-closing milestone payments, similar to an earn-out.
There might be additional payments when certain milestones are reached, such as a development-completion payment, a notice-to-proceed payment, and a commercial-operation-date payment, or there might be milestone payments specifically tailored to the project, such as payments if additional acreage is leased, a power purchase agreement is signed or a tax abatement is obtained.
A seller will not want to bear risk for things in the buyer’s control, such as financing and construction, and will argue that any back-weighting of the milestones should stop at development completion and not extend to notice to proceed with construction or commercial operation.
Buyers conversely will not know whether the development assets they are purchasing will bear fruit as intended until commercial operation and will want to hold back as much consideration for as long as possible.
Any milestones should be defined clearly and objectively to avoid acrimony later. For example, be clear that notice to proceed means issuance of a FULL notice to proceed and for which contracts (for example, engineering, procurement and construction contract, turbine supply agreement, balance-of-plant construction agreement). If the buyer might perform some tasks itself or issue a number of limited notices to proceed, consider adding other milestones for significant work or equipment delivery on site. For commercial-operation-date payments, be sure to tie the payment date to commercial operation as defined in a particular contract (and make sure the contract defines the term) or else refer to mechanical or substantial completion under the construction contract or use an appropriately defined term in the interconnection agreement.
The purchase price is often based on dollars per watt (direct current in a solar project) of nameplate capacity. Payments made before notice to proceed with construction — called NTP — are typically based on an agreed estimate that is adjusted later — trued up — to the nameplate capacity in the construction contract when construction starts and then later to the as-built nameplate capacity at commercial operation. Simple capacity true-up provisions might not address complexities that can and do arise, such as when a buyer acquires additional acreage itself or from a third party, but uses the seller’s interconnection rights. Sellers may also require a floor price to ensure the buyer uses the full capacity of the project that the seller developed and for which the seller wants to be paid.
A separate development services agreement is a way to give the seller part of what would otherwise have been a back-weighted purchase price in the form of a monthly service fee. A development services agreement can be a way for the seller to remain involved in the project through to completion, but sellers should be wary of default provisions that could allow for termination of the contract for minor breaches before the bulk of the consideration is paid. Development services agreements also have the potential to convert the amounts received into ordinary income for performing services as opposed to capital gain from sale of the project.
Sellers will often argue that any post-closing milestone payments must be protected in the event that the buyer does not develop the project. What if the buyer is just trying to take the seller’s project off the market to boost the value of one of buyer’s other projects? Negotiations around a buyer covenant to develop the project tend to break down over subjective good-faith and commercially-reasonable-efforts standards.
Sellers sometimes convince buyers to allow the seller an option to buy the project back, but the details are difficult: what are the buyback trigger events, price, terms and conditions? What if the buyer returns the project to seller in worse shape than when the buyer bought it? Outside dates on milestone payments can help a seller gain comfort that the buyer will continue to develop the project. For example, the buyer’s failure to make a milestone payment by an outside date would trigger a buyback right for the seller.
Sellers will also often argue that any post-closing milestone payments must be backstopped by a creditworthy entity. If a buyer parent guaranty or a letter of credit is not available, then a seller might offer a lien on the project in the amount of the post-closing payments. Buyers will require any such seller lien to be subordinated to any liens arising under any construction or project financings or under any offtake or hedge agreement, and buyers should expect that construction or project financiers will request that seller’s right to a lien be terminated before construction starts.
As in any M&A transaction involving an interim period between signing and closing, buyers will require certain conditions precedent be met before closing.
Third-party consents and regulatory approvals (such as CFIUS and public utility commission filings) tend to be relatively uncontroversial, but are important to identify early in the transaction.
Buyers have a list of development tasks they usually want completed before they will close. Sellers try to move as many of these after closing as the buyer will allow.
Sellers should think through possible mitigants when accepting crossing agreements, title-cure measures and other real property matters as conditions to closing: could the issue be designed around or addressed with insurance?
Sellers should also be aware that recipients of estoppel requests tend to see them as an opportunity to charge money. Conditions precedent involving unincentivized third parties tend to be unpredictable and should be factored into timelines. The theory of the transaction, meaning how the seller and buyer are sharing development risks and rewards, should manifest itself most obviously in the sorting of development items into conditions precedent and post-closing milestones.
The parties should also pay close attention to how each condition is defined to avoid disagreement later about whether an item has been completed.
The seller’s representations and warranties are important to the buyer as a diligence-and-disclosure mechanism — the disclosure schedules in particular are an important part of diligence — as a risk-allocation mechanism through the indemnification provisions, and as indirect conditions precedent given that the seller’s representations and warranties usually must be true and correct in all material respects as of the closing date.
The seller will make representations and warranties about the project assets as well as the project company. A renewable energy project in the development stage is not an operating business that is generating revenue. A seller will ask that standard M&A representations be pared back accordingly, and the buyer will ask to tailor the representations to the project and the available diligence materials.
Many representations are routine and not controversial, but there is a handful where disagreement is likely. One is the so-called sufficiency representation. Buyers will ask that the seller state that all the assets, including all real property, contracts, permits and studies, are sufficient to develop, construct and operate a project with the estimated nameplate capacity. Sellers will argue that construction and operation are the buyer’s responsibility, that other representations adequately address the individual assets, and that the seller cannot guarantee the ultimate size or productivity of an unbuilt project. Title work may not be completed by closing and crossing agreements cannot be finalized until the design is final, which rarely happens by closing for a development-stage transfer.
Another is the so-called 10b-5 representation, named for the section of the 1934 Securities Exchange Act from which the main verbiage is drawn. Sellers try to push back wholesale on the provision as a liability trap, although they often find themselves begrudgingly agreeing to a limited and qualified version, particularly if they have limited negotiating power in the transaction.
If the project is supposed to qualify for federal tax credits, the buyer will almost always require a representation that it was under construction in time for tax purposes to qualify. Sellers offer to represent facts that will allow the buyer to draw its own conclusion rather than represent a legal conclusion.
The disclosure-schedule-update provisions addressing when a change during the interim period between transaction signing and closing should relieve the buyer of its obligation to close and what indemnity the buyer should be paid for breaches of representations are also heavily negotiated. Buyers often already have a no-material-adverse-effect condition precedent, but the material-adverse-effect standard requires a significant change, and buyers might use the disclosure-schedule-update provisions as a mechanism effectively to lower that materiality threshold. These provisions tend to be long, wordy and full of double negatives, so the parties should pay close attention to ensure that they do not have the effect of rewriting the conditions precedent.
Renewable energy projects have been receiving greater attention from investors and lenders, and many buyers report a weariness toward managed-and-marketed sales processes.
This “auction fatigue” reportedly feels to buyers like a cost of capital shootout. Particularly if the project is being marketed as “shovel-ready,” incongruous buyer and seller theories of the transaction may be latent in the bid stage only to appear in the purchase and sale agreement, after both parties have spent considerable time and effort on the transaction. Some buyers abstain from auctions altogether, while most participate selectively while simultaneously pursuing bilateral relationships with individual developers giving the buyer informal or formal access and visibility into the developer’s pipeline.
Many developers, investors and lenders have at some point tried their luck on a project where there was a binary risk, such as a state or local incentive for which the project either qualified in full or not at all. This strategy can work if spread out over a portfolio, but in isolation can squander precious resources. Most developers, and increasingly equity investors, prefer non-binary risks that can be controlled or mitigated with effort, and as a result many larger institutions are becoming better-versed at development. As the universe of developers has become deeper and more diverse, we have seen more portfolio acquisitions, which might be documented in multiple single-project purchase and sale agreements or a single portfolio-wide purchase and sale agreement, and we have also seen more corporate platform M&A where a strategic or financial player will acquire an established developer to bring the development expertise and ability to generate a project pipeline in-house.
Another trend in the marketplace for North American renewable power projects is an increase in foreign buyers, particularly from Asia. One result is that sellers should assume a full CFIUS process into their closing timeline. This can add four to five months. CFIUS is an inter-agency committee of 16 federal agencies that reviews foreign acquisitions of US businesses and assets for national security implications. Filings used to be voluntary, but are now mandatory in some transactions. (For more detail, see “Scrutiny for US Inbound Investments” in the October 2019 NewsWire.)
As regulated utilities and the regulatory commissions have become increasingly open to renewables, we have seen a shift from utility power purchase agreements toward build-transfer or build-own-transfer agreements. Utilities often require that their power purchase agreements contain regulatory-out clauses, meaning that if the utility is unable to pass through to its ratepayers the amount it pays under the contract for electricity, the utility can terminate the power purchase agreement. Projects with power contracts with regulatory-out clauses are hard to finance. Developers counter by asking utilities to put their power purchase agreements through a full regulatory approval process before construction starts, to which utilities respond, “Fine, in that case perhaps the utility should just own the project.” The resulting build-transfer agreements are like a purchase and sale agreement with a full engineering, procurement and construction contract pasted in as a condition precedent to closing. (For more discussion, see “Emerging Themes in Build-Own Transfer Agreements” in the December 2019 NewsWire.)