by Leslie Hodge
Background: There are multiple avenues to funding an asset through development. We at Segue have noticed a theme where traditionally late-stage capital providers convince themselves to provide earlier-stage development capital, but on terms that both parties will ultimately come to regret. Below, we touch on one phenomenon we’ve seen (sitting on both sides of the table) and offer some advice on pre-wiring offramps for getting out of a sticky situation.
Project scarcity, bubbling liquidity, and good old-fashioned return-chasing have pushed capital providers earlier and earlier into the renewable development cycle. In many cases, internal champions at these capital providers have worked tirelessly and in good faith to explain and socialize development risks within their respective organizations, enabling these capital providers to execute on transactions well before NTP. Definitive agreements are inked, press releases published, and everyone looks fantastic on LinkedIn.
Then, hand-and-hand with the developer, these capital providers enter a new world. Development is inherently messy. It requires a local presence, knowledge, patience, and thick skin. Human relationships matter in ways that are not quantifiable on paper. Project costs, valuations, and schedules can swing depending on the outcome of a single study, a slight regulatory change, a vote in a town council meeting, an individual appointment at the state commission, the list goes on. It’s no wonder that sometimes, even where a definitive agreement clearly states a development milestone, such as “all discretionary permits obtained,” there may be a bona fide disagreement about whether that milestone has been achieved.
If the capital provider and the developer do not see eye-to-eye, what happens? What happens if the capital provider decides not to fund the milestone? What if such failure to fund jeopardizes the viability of the project? More pointedly, what if the capital provider decides to abandon the project? These are all questions that developers should consider before accepting any offers of development capital (and ideally before granting exclusivity to a capital provider).
The answers are informed by the risk tolerance of the capital provider. If the risk tolerance of the capital provider is unknown or subject to change (i.e., turnover of individual people on the deal team), well… then that is a risk to the developer and one that should be taken very seriously. Below are some considerations that should be addressed at the term sheet stage.
If the term sheet has been drafted by the capital provider, it may not expressly contemplate the capital provider’s abandonment of the project. But it should. Here are some questions to ask:
- Under what circumstances do I have the right to take the project back? For instance, must the capital provider affirmatively state “We do, hereby and henceforth, abandon the project!”? Or is there a mechanism for a deemed abandonment where the capital provider has failed to fund? For instance, 90 days of failure to fund may feel like abandonment to a developer. Whereas certain capital providers may argue for 6 months or even a year to decide whether to fund the project. If there is a de facto option to suspend funding, the developer should know that from the outset.
- What does it cost to buy the project back? Capital providers may expect to have all sums that they paid refunded by the developer. They may expect an additional reimbursement of their third-party costs. In some instances, they may ask for interest on sums paid and third-party costs. For many developers, this buyback cost effectively prices them out of continued development - they have no way to access any value from the asset.
- How would a buy-back option work mechanically? The parties may agree to a short form of assignment or a form purchase agreement, but the more common approach is for a capital provider to punt and require that the parties negotiate a transfer agreement at a later date. Kicking the can may save the headache of negotiating a form document today but could set the stage for a negotiation stalemate down the road when the parties are in dispute and out of economic alignment.
Beyond the Documents
Beyond the text of the term sheet, it is important for developers to work with capital providers that understand renewable development and its risks at each stage. Before transacting, it is good practice to probe as to whether the specific team the developer is working with has experienced the ups and downs of development. Similarly, it is critical to understand if such team will also be the decision makers at critical funding points, and – if not – who does make the decisions (and is it reasonable to trust that the decision makers will take the recommendations of the team that is in the trenches with the developer)?
Breaking up is hard to do. Developers are wise to consider what a breakup with their counterparty would look like, to ask questions, and to negotiate a position that allows the developer to keep the value they’ve created.
We created Segue because we believe that certain developers need flexible capital that truly understands early-stage development risks, patiently supports them through the (economic and emotional) ebbs and flows of development, and most importantly, gets out of the way to allow developers to do their job.