Partnership Flip Transactions

Partnership Flip Transactions

July 13, 2015

A partnership flip is a simple concept. A sponsor brings in a tax equity investor as a partner to own a renewable energy project together. The partnership allocates taxable income and loss 99% to the tax equity investor until the investor reaches a target yield, after which its share of income and loss drops to 5% and the sponsor has an option to buy the investor's interest. Cash may be distributed in a different ratio before the flip.

  • cash drought
  • yield cos
  • call option 

 

Basic Yield Flip

The IRS issued guidelines for partnership flip transactions in 2007. The guidelines provide a "safe harbor" for transactions that conform to them. M ost do. The IRS said recently that the guidelines were written with wind projects in mind and are not a safe harbor for solar transactions.

  • central tension 

 

There are two main variations in flip structures. In addition to the yield-based flip, there is also a fixed-flip structure that leaves as much cash as possible to the sponsor.

  • 2% preferred cash distributions
  • put and call 

 

Fixed Flip

Some yield -based flip deals have a "pay-go" feature where the tax equity investor makes payments overtime that are a percentage of production tax credits for electricity sales. The IRS guidelines limit such pay-go payments to 25% of the total tax equity contribution. Project-level debt is unusual.

  • forbearance 

 

Flip deals are different than sale-leasebacks in terms of the amount of capital raised, risk allocation and the timing of when the TEI must invest. A sale-leaseback provides the sponsor with the full market value of the project in theory. In a flip, the TEI contribution is usually 40% to 85% of the market value; the sponsor must provide the rest.

 Turning to risks, in a sale-leaseback, the sponsor has a hell-or-high-water obligation to pay rent and must pay for the residual value if it wants to keep the asset at the end of the lease. In a flip, the TEI's return turns on how well the project performs. The TEI's protection is it sits on the project at a 99% level until it reaches its target yield. There may be cash sweeps. It has only a
limited residual interest.

  • weather
  • technology
  • offtaker credit 

 

Tax risk tends to be allocated the same way as in asale-leaseback, but without significant tax indemnities. Tax risk is allocated through limited representations and a set of "fixed tax assumptions."

Turning to timing, in ITC deals, the TEI must be a partner before the assets are placed in service. In some transactions, the TEI makes enough of its investment before the project is put in service to be a partner and contributes the rest after final completion. It does not matter in PTC deals when the TEI becomes a partner.

  • unwind risk 

 

The TEI may invest by buying an interest in the partnership from the sponsor ("purchase model") or by making capital contributions to the partnership ("contribution model"). The purchase model may give the TEI a larger basis step up for calculating tax benefits.

The sponsor is responsible for day-to-day management of the project. TEI consent is required for a list of "major decisions."

The TEI is barred from transferring its interest to a competitor of the sponsor, to a "disqualified person," or to anyone if the transfer would cause the partnership to terminate unless the other partners have been indemnified for the ad verse tax effects. Club deals where two or more TEIs invest alongside each other are ommon in larger transactions.

  • timing 

 

Almost all partnership flip transactions have "absorption" issues. Each partner has a "capital account" and "outside basis" that are two ways of measuring what the partner put into the deal and what it is allowed to take out in benefits. Most TEIs run out of capital account before they are able to absorb 99% of the depreciation.

Among the other recurring issues in deals are the following:

  • output forecasts
  • pre-tax yield
  • book loss
  • change-in-law risk
  • affiliate sales
  • merchant risk

 

Keith Martin