By Conor McKenna, SPW Contributor
You hear this story pretty regularly in the U.S. market: a solar sponsor develops a ‘good’ project with all the necessary boxes checked: Site control, a signed PPA, an interconnection agreement and permits well under way. The developer has found a buyer at a given acceptable price, and the developer expects the project to be ready to close in four to six weeks.
Four months later, the project is in limbo, with one or both sides having walked away and leaving the once-confident developer scrambling to find a new buyer. Why does this happen? Even with an ideal project, problems in the deal negotiation make a ‘good’ project go ‘bad.’ Here are the five most common issues that often prevent a good project from closing.
Finding The Wrong Buyer
Contrary to popular belief, the number of prospective buyers, the value of the bids and the favorable initial terms do not guarantee a successful sale or financing. Instead, it’s about finding the right partner for the right project and sponsor. During a deal process, a good buyer looks for a developer who can deliver: They will spend months of due diligence and hundreds of thousands of dollars ensuring that they receive the value they require from a project.
It is equally important for a seller to conduct due diligence on the buyer. It isn’t just about the how well-known the buyer is or the size of their initial bid. At larger institutions, the deal may get buried underneath multiple levels of approvals that can drastically change the initial deal terms. Even worse, buyers may pull the old bait and switch, promising sweeteners for project exclusivity, only to change the terms once they know they have sole access to the project. Many times the deal will change so much that by the end, it becomes uneconomical to the seller to consummate the transaction.
Accordingly, when we represent sellers we attempt to steer them towards certain buyers based on the following criteria: The buyer makes sense as a long-term partner, will work with the developer on the issues that inevitably arise, will be persistent in seeing the project(s) reach completion and appears willing to adhere to the spirit of the initial agreed upon terms.
Lack Of Financing
For most projects, finding sponsor-equity financing is only one piece of the capital stack. Debt and tax equity are also critical, especially given the U.S. Investment Tax Credit (ITC) benefits. If a buyer looks to lever the deal or does not have internal tax capacity to monetize the ITC and depreciation benefits, it’s essential that all of the necessary participants are identified and will cooperate to achieve closing. There are issues that must be addressed throughout the process.
For example, debt, equity and tax equity investors all need to get comfortable with the priorities of cash flows, and they need to agree on the interparty terms. Even if the equity gets comfortable with the acquisition, if the other components of the capital structure lack financing, the project will not get built. We always look for an equity partner’s track record in the market, not just in finding debt tax equity for deals but debt and tax equity with the same key characteristics as the project in front of them.
Where possible, we advise sellers not to allow buyers of their projects to make their purchase contingent upon the buyer’s financing. Too many buyers use this contingency to lock-up deals without putting real skin in the game until they have their own financing in place. More often than not, it puts the seller in a difficult position when the financing takes longer than the seller anticipated.
The term “NTP” or “Notice to Proceed” may be one of the most overused terms to define a ‘good’ project. ‘NTP’ is subjective. The definition varies based on the buyer’s requirements. I have yet to see a project truly at “NTP” before a process starts with a prospective buyer. A seller may feel that a project is completely clean and ready for construction, but if the project fails to meet investor committee approval and/or counsel approval, the project does not move forward — and the seller has to go back to the market. It’s helpful to know what a given buyer or their counsel’s hot-button points are for determining NTP. In absence of this information, we have developed a generic template of NTP-related issues that typically come up on a deal for equity, debt and tax equity to use as a checklist against a specific project.
Expectations, Emotions And Loss Of Perspective
When you are selling projects in an auction process or even on a bilateral basis, initial bids from prospective buyers will be based on best-case assumptions, meaning that the purchase price will be contingent on all of the assumptions and representations made by the seller or the seller’s advisor remaining true. Since even the best assumptions made by the most experienced project developers change continuously as you go through the sales process, some of those assumptions will change for the better, while some will change for the worse.
Any time there is a change in value attributed to a project, there is the potential for a seller to feel slighted. Some buyers will attempt to renegotiate the purchase price during the negotiation, while others will look to maintain the agreed to economics in the face of an adverse change in the assumptions in a project. I have seen many sellers anchoring a value to a project despite new information negatively affecting the value of the project to the buyer. Although values and the ultimate economics fluctuate in every deal, many parties deal with these changes from an emotional, as opposed to a rational, standpoint.
While it’s easier said than done, especially given how long some deals can take, the key is to maintain an objective perspective in an otherwise subjective situation. To prevent a deal from collapsing, developers must understand the magnitude that a given change in a project can have on the buyer’s economics. The best way to deal with these changes, aside from remaining objective, is to have transparency between the parties on the true economics of the project. Typically, in our transactions, we attempt to create a financial model that is shared by the buyer or seller, or one that at least demonstrates the basic economics, so each change can be modeled to demonstrate the impact on the original economics.
Running Out Of Time
No matter how much time you think you have, there is always a rush against the clock. Despite the best attempts, it seems as if there will always be last minute work prior to the close. There are always missed material issues that come up near the expected closing date that must be addressed. From my previous deals, I’ve found there are two things that must happen to protect from any last minute collapses. First, address all known issues early to allow for a problem-buffer should any last minute issues come up. We’ve found that it’s critical to manage all third parties, including lawyers, technical teams, third-party analysts, the counterparties and the development team, to ensure each piece falls into place at the right time. Second, we look to address as many issues as possible early in the process. If you can preemptively point out the potential gaps or hurdles, there is less of a chance these issues will jeopardize a deal.
While none of these issues are unsolvable, they do require a significant amount of time and energy that may not always be considered when initially developing a project. With the proper discipline and objectivity, overcoming these five hurdles may increase the chances of monetizing solar projects successfully.
Conor McKenna is vice president of Reznick Capital Markets Securities. Working alongside CohnReznick LLP and CohnReznick Think Energy, Reznick Capital Markets Securities offers one of the most comprehensive financial advisory platforms in the industry.
Mark Stout says
Agreed, Kevin. Those two roles have very different skill sets.
Kevin Swartz says
I think that is also just a fact of the solar industry is that so many new people claiming to be developers have entered the market, many project have development flaws. Conor hits some of the main agreements that need to be in place, but site control, PPA, interconnect and permit application filed isn’t really enough. Can you back up your CapX estimates? Have you received bids from suppliers? Have you talked to Lenders about debt? Can you get the project built and run it for a year and then sell it? (there is a large potential upside to the sellers if they can do this) How sure are you of your yearly generation estimates? Have you been measuring solar radiation on site? Are you ready with a plan for construction? Do you have construction power on site? Where will you get the water for dust control and panel washing?
People who were selling equipment one week ago ( no matter how bright) really don’t the skills it takes to develop a solid project and cover all the necessary bases that need to be planned for and , in many cases, fully contracted.
Tom Vogt says
Conor, great article. You just described why my company and software for the solar acquisition process exist. You articulated the inconsistencies and challenges of this industry very well.
dixiesolar king says
Is it okay to “vet” a buyer without offending or blowing the deal?