In our previous article we provided an overview of the clean energy sector for those investors who wanted to learn more about the potential investment opportunities. In this edition of the Clean Energy Investment series we turn our attention to private equity, and the opportunities this provides to developers of renewable energy projects.
There has been a particular focus on private investment in green technology recently, with prominent articles being features in the The Telegraph (paywall) and Financial Times. Private investors are emerging as one of the key drivers of the post-subsidy solar boom, but it is not just solar developers who can benefit from a private equity market that is increasingly pushing for ethical deployment of capital.
In its most basic form, private equity is the investment of money in a private company in return for shares, meaning the investor is essentially buying a percentage of the company. The easiest reference point for this is the TV show Dragon's Den where the dragons offer a certain level of investment for a certain percentage of ownership in the pitcher's company.
After an agreement is reached between the company and the investor, the investor will enter into an investment agreement that governs the terms on which the investment is made. This will not only detail the number of shares to be issued, but will usually contain certain warranties about the company to ensure that the facts and circumstances on which the investor was willing to invest are true at the point of investment.
Following entry into the investment agreement and the subscription for shares by the investor, the investor will pay the agreed amount to the company, and the company will issue and allot the agreed shares to the investor. From thereon out the investor will be a shareholder in the company.
Alongside the terms of the investment, the terms of the ongoing relationship between the investor will also be agreed at the pre-investment stage. Depending on the type of investor (as described in more detail below), a full-fledged shareholders' agreement may be entered into (or included in the investment agreement), or there may just be some basic provisions inserted into the investment agreement in order to protect the fundamentals of the investment. We will explore the detail of these arrangements in our future article on joint venture and shareholder agreements.
There are a number of different ways in which developers can raise funds and investors can choose to invest, depending on exactly what they are seeking.
If the developer is looking to build a relationship and utilise the expertise and contacts of the investor, then it makes sense for the investment to come from a small number of high net worth individuals or one or two companies. From the investor's point of view, they will be interested in having a significant stake in the company as they will be actively working with the company to develop these projects, and as such will want to substantially participate in the profits once the project is generating electricity or sold to a third party. Such an investor will also want to have the right to have a say in the running of the company and development of the project, in order to ensure their financial and time investment is protected.
It may be however that the developer is not looking for a "partner", and instead just wants the cash to develop the projects, or an investor may not be interested in getting involved with the running of the business and just wants a return on their money. In this case the developer may seek a high number of passive investors who individually put a small percentage of the necessary funds into the company, and essentially sit back and allow the developer to carry on with the day to day running of the company/development of the project. There will still be some fundamental matters in respect of which the developer will need to obtain the passive investors' consent, but they will generally be less onerous than those expected by a "partner" investor and will mostly cover the absolute fundamentals that may adversely affect their investment.
When looking for passive investors, developers may look towards crowdfunding to secure the financing they need. There are a number of platforms available for businesses wishing to raise funds through crowdfunding (simply type "crowdfunding platforms" into your search engine of choice). In these situations investors will often number in the hundreds, with some investing as little as £10. Already in the UK over 120 clean energy projects have already received finance through crowdfunding. Notably the tidal industry, which is starting to draw more and more companies and investors, have recognised the potential of crowdfunding, with Orbital Marine Engineering recently starting a £7m crowdfunding process in respect of a potential new tidal plant off the coast of Orkney.
One of the main issues that need to be given consideration by a developer in the early stages is whether the project is best suited to a private equity investment, or is better financed by way of debt finance.
A key factor will be the risk profile of the project. The clean energy market is constantly evolving, with not only new technologies coming to the fore, but also new ways of implementing older technologies. Whilst this evolution is exciting for developers and has the potential to unlock greater levels of reward, novel approaches often deter lenders, who are seeking a steady return on the amount they have loaned, and have no participation in the ultimate upside. By contrast, equity investors will have a higher risk appetite, although will also expect a higher return to compensate for that risk.
Unlike with a loan, it is unusual to see any set recurring payment provisions to an equity investor, meaning that investors won't expect any money to be paid to them until the project is up and running (or sold for a profit at the development stage). It is therefore easy to see how private equity investments would be attractive to developers who are at the early stage of developing their project when cash flow is tight.
The ultimate aim of almost any private equity investment is to realise the financial gains through an exit (i.e. a sale of shares or assets). Few investors end up holding onto the assets and taking their share of the generational income for the life of the project. Typically an investor would want the company or project to be sold to a third party for a profit once the work for which their investment was paying for had been completed.
To give a very basic example, let's say that a developer owned a project company that had obtained planning permission, land rights, and a grid connection offer, but did not have the financial ability to fully build the project out. A private equity investor may agree to make an investment in the company to enable it to build out the project, in exchange for a certain percentage shareholding and on the condition that once the project had been built, the project company would be sold to a third party buyer. The proceeds from this sale would be distributed to each shareholder (including the investor) in accordance with the percentage of their shareholding, meaning the investor is able to realise the gain on their investment in reasonably short order (or usually at least within a 5 year window), instead of receiving income from the project revenue streams over a 25 year period.
It is therefore vital that any developer seeking private equity investment is clear on what the exit strategy will be. At the point of exit the buyer will, in almost all circumstances, want to buy the entirety of the project company, including the shares of the developer. As a result a developer who instead wishes to hold onto the project for its entire life will need to make sure any potential investors are aware of this and on-board at the outset.
There is no doubt that private equity investment will continue to play a significant role in the development of renewable energy projects. Developers who are aware of the options available to them, are organised, and have a clear strategy, will be well placed to tap into a market that is increasingly leaning towards green investments.
This publication is intended for general guidance and represents our understanding of the relevant law and practice as at December 2018. Specific advice should be sought for specific cases. For more information see our terms & conditions.