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By: Scott Anthony, Eric Blanchard, and Matthew Gehl, Covington & Burling LLP
The clean and renewable energy industry focuses on alternative energy solutions to traditional fossil fuels, which currently dominate the supply of energy across the world. Unlike traditional fossil fuels, which are potentially finite in availability and can generate relatively high levels of pollution, clean and renewable energy sources generally do not face comparable availability concerns and can supply energy with a smaller footprint on the environment.
The major clean and renewable energy sources include biomass, solar, and wind power, among others.
Biomass energy is organic material from which energy can be obtained and includes sources ranging from wood to waste-to-energy to landfill gas. This energy can be obtained both by burning the biomass directly (e.g., wood and manure) as well as converting the biomass to a different form of usable energy, such as ethanol, which can be added to gasoline to power automobiles. Major producers of biomass and biofuels include Green Plains Inc., an ethanol manufacturer who went public in 2007; BioAmber Inc., which sells a biologically produced, chemically identical replacement for petroleum-derived succinic acid, and which completed its initial public offering (IPO) in 2013; and FutureFuel Corp., a company that produces and sells biodiesel, a renewable energy fuel, and went public in London in 2007 before its later U.S. listing. Renewable Energy Group, Inc. is another major player, operating a network of 10 biomass-based diesel plants.
Solar energy is generated by converting sunlight into electricity. This occurs by a variety of mechanisms, including the use of photovoltaic panels or cells to convert sunlight into electricity and thermal collectors to gather heat from the sun. Solar energy is currently the most active segment of the clean and renewable energy industry, with companies such as Yingli Solar and Trina Solar focusing on the manufacture of solar panels. In addition, companies including SunPower, First Solar, SunRun, and SolarCity not only manufacture solar panels and systems, but also offer installation packages on a variety of levels spanning from utilities to residential. These companies may allow consumers to purchase a solar system outright, to lease a solar system, or to have a solar system installed and pay for the power produced.
Wind energy is typically generated by building wind turbines to harness and generate electricity. The energy harnessed by the turbine can be used either locally or as part of a larger wind farm that is connected directly to provide power to an electrical grid. More so than most sources of clean and renewable energy, the production of wind turbines requires a substantial initial capital outlay, thus leaning more heavily on the project finance markets than traditional equity or debt capital markets for capital raises. There are relatively few companies that are publicly listed on a major U.S. exchange that are purely focused on wind energy. General Electric is a major player in this space, and a handful of others trade over the counter, including Nordex, Siemens, and Vestas. Other participants include wind farm developers, many of which take the form of yieldcos (i.e., companies that seek to generate cash flows from a group of assets and then pay it back to investors as dividends), including Hannon Armstrong Sustainable Infrastructure, Pattern Energy Group, and Brookfield Renewable Energy Partners.
Clean and renewable energy companies focus on developing and commercializing one or more alternative forms of clean and/or renewable energy. As noted above, however, companies specializing in different types of clean or renewable energy may approach capital-raising differently. Companies developing biomass or, more recently, solar energy have tapped the U.S. equity capital markets to raise money. On the other hand, because of the substantial capital required at the outset, companies hoping to fund the construction of wind turbines or other types of production facilities have gravitated to the project finance space as a way to raise the necessary funds. In addition, earlier stage and/or private clean energy companies have had access to a growing pool of venture capital and seed funding. According to CB Insights, a data analyzing service, global investments in the clean energy financing market were $3.2 billion, $3.7 billion, and $3.8 billion for 2013, 2014, and 2015, respectively. Although a strong fourth quarter helped to stabilize investments for the year, funding in 2016 constituted a drop-off to this growth trend. Roughly half of this financing has come at the seed/angel stage, together with Series A through D financing rounds (discussed later under Startup Financing). Major financing rounds from 2016 have included $1 billion in Series A to WM Motors (Chinese electric vehicle), $120 million Series A to Chehejia (Chinese electric vehicle), $200 million to United Wind (U.S. wind), and $169 million to SITAC RE (Indian wind).
Securities offerings are governed by a comprehensive set of laws and regulations that are applicable across industries. At the federal level, the two fundamental statutes that comprise the framework for securities regulation are the Securities Act of 1933, as amended (the Securities Act, 48 Stat. 74), and the Securities Exchange Act of 1934, as amended (the Exchange Act, 48 Stat. 881). Both statutes establish a disclosure-based regime designed to provide investors with enough information to make an informed decision about whether to purchase or sell a company’s securities.
The Securities Act was designed to regulate the offer and sale of securities by (1) requiring companies to provide material financial and other information concerning the securities being offered for sale and (2) imposing liabilty for fraud, deceit, or other misrepresentation in the sale of securities. In order to achieve these two objectives, the Securities Act requires that every offer and sale of securities in the United States be registered with the Securities and Exchange Commission (SEC), unless an exemption from registration is available.
In general, offers may not be made until an issuer files a registration statement with the SEC. The registration statement, which includes a prospectus that must be delivered to investors, discloses certain qualitative and quantitative information about the issuer (including its business and financial operations) and the securities being offered for sale. Before a sale can be consummated, an issuer’s registration statement must be declared effective by the SEC, typically following a review of the registration statement by the SEC staff, unless the issuer is a well-known seasoned issuer who qualifies to file an automatically effective registration statement.
The Securities Act imposes statutory liability for any material omissions or misstatements in the registration statement and prospectus, as well as any other documents furnished to a purchaser of securities under the Securities Act.
However, not all securities offerings must be registered with the SEC. There are various safe harbors and exemptions from registration that include, among others:
The private placement exemption is widely relied on by issuers, with a number of safe harbors that help to facilitate capital raising. Among the most commonly utilized, Regulation D of the Securities Act contains safe harbors that allow issuers to raise up to $5 million (Rule 504 (17 C.F.R. § 230.504)), or an unlimited amount subject to limitations on the type of permitted investor (Rule 506 (17 C.F.R. § 230.506)). Rule 144A (17 C.F.R. § 230.144a) permits resales of certain qualified securities to sophisticated, large institutional investors and is frequently used for debt financing and offerings of other securities that are not listed on a national securities exchange. Regulation S (17 C.F.R. §§ 230.901–905) is a safe harbor utilized for offerings made exclusively outside of the United States.
The Exchange Act was created to govern securities transactions on the secondary market and requires that companies with a security listed on a U.S. stock exchange, meeting certain asset amount and shareholder number requirements or making public offerings of securities in the United States, register such securities and file certain periodic and other reports with the SEC. These reports contain information similar to the information required in a registration statement under the Securities Act. In addition, the Exchange Act provides for the direct regulation of markets on which securities are sold (i.e., stock exchanges) and the participants in those markets.
A foreign clean and renewable energy company may qualify as a foreign private issuer (FPI) as defined in Rule 405 (17 C.F.R. § 230.405) under the Securities Act and Rule 3b-4 (17 C.F.R. § 240.3b-4) under the Exchange Act. A foreign company will qualify as an FPI if 50% or less of its outstanding voting securities are held by U.S. residents and none of the following three circumstances applies: (1) the majority of its executive officers or directors are U.S. citizens or residents, (2) more than 50% of its assets are located in the United States or (3) its business is administered principally in the United States. FPIs are entitled to reduced regulatory and reporting requirements under both the Securities Act and the Exchange Act.
Additional Statutes and Regulations
In addition to the Securities Act and the Exchange Act, there are several other federal statutes that regulate various aspects of public company conduct, market conduct, and securities offerings. These include:
The SEC and the Financial Industry Regulatory Authority (FINRA) are the principal regulatory agencies that oversee the capital markets and capital formation activities in the United States. The national securities exchanges, such as the New York Stock Exchange (NYSE) and the NASDAQ Stock Market (NASDAQ), also perform oversight functions and impose a number of regulations that can impact capital raising.
In addition to the federal securities laws, each state has its own set of securities laws that are commonly referred to as blue sky laws. Securities offerings are subject to blue sky laws, although the National Securities Markets Improvement Act of 1996 has largely preempted many state securities laws.
Lawyers working with clean and renewable energy companies should be aware of the major federal laws and regulations that govern the industry, including rules and regulations promulgated by the U.S. Energy Department and the Environmental Protection Agency (EPA). These laws and regulations provide for certain quality and safety standards, in addition to regulating land use, the disposal of hazardous waste and materials used in the production of certain alternative energy sources, and the creation of certain tax and other incentive programs to promote the development and commercialization of clean and renewable energy. Applicable regulations include:
In addition to the foregoing list, internal and, more so, external counsel should track developing legislation and potential changes in regulations. Regulations affecting the clean energy sector are constantly evolving. New regulations are being considered and old regulations may be eliminated. In addition to tracking developments, companies should consider being involved in shaping the legislation through industry trade groups and other lobbying efforts. Tax credits, emissions standards, regulations regarding connecting to the power grid, and other matters are likely to be the subject of legislation. That provides industry the opportunity to influence the rules under which it will operate. There are plenty of organizations that allow smaller companies to participate in the process without spending significant amounts of precious capital.
The new U.S. administration may inject regulatory uncertainty within the industry. Many clean and renewable energy companies are closely watching for how President Trump’s administration will roll back or revise President Obama’s clean power plan (CPP). In August 2015, President Obama and the EPA announced the CPP, which created the first-ever national standards to address carbon pollution from power plants. The plan established state-specific standards for carbon dioxide emissions from coal-burning power plants. While states were free to experiment with the means used to meet such standards, they were required to submit detailed emissions reduction plans. Almost immediately after the plan was finalized, opponents initiated challenges to it in court, arguing that the new policy exceeded the legislative authority granted in the 1990 Clean Air Act. While litigation is ongoing in the U.S. Court of Appeals for the District of Columbia Circuit, the new Trump administration is presenting a more direct path toward terminating the plan. Scott Pruitt, the new administration’s head of the EPA, has publicly criticized the CPP on both policy and constitutional grounds. In addition, on March 27, 2017, Trump signed an executive order directing the EPA to review the CPP, which is widely expected to roll back the CPP. The Trump administration is also expected to roll back or revise other rules and regulations enacted during the Obama administration aimed at reducing carbon emissions.
Conversely, the Chinese national energy agency recently announced its intention to spend more than $360 billion on renewable energy through 2020. As U.S. government support for renewable energy initiatives declines, companies may want to consider additional disclosure relating to the potential resulting competitive disadvantages.
A recent development that may assist clean and renewable energy companies in their capital-raising efforts is the 2015 adoption of amendments to Regulation A (informally known as Regulation A+), which update and expand exemptions from SEC registration for issuances of securities of up to $50 million in a 12-month period. The clean and renewable energy industry has struggled to raise public equity capital in recent years due to political and regulatory uncertainty, a number of high-profile bankruptcies, and what is often a lengthy path to profitability. As such, the implementation of Regulation A+ provides another avenue for companies to raise much-needed equity capital without undergoing the lengthy process of SEC registration and becoming a public company.
Regulation A+ creates two tiers of exempt offerings. Tier 1, for offerings of up to $20 million in a 12-month period, and Tier 2, for offerings of up to $50 million in a 12-month period. Tier 1 issuers are subject to state blue sky registration and qualification requirements but are subject to minimal continuing reporting obligations. Tier 2 issuers are exempt from state blue sky registration and qualification requirements but are subject to ongoing periodic reporting requirements. The process involved in a Regulation A+ offering is fairly similar to a traditional public offering. For instance, issuers must still prepare and file an offering document with the SEC (Form 1-A), subject to SEC review and comment, including an offering circular used to market to investors. However, the reporting obligations for both the offering document and on an ongoing periodic basis are reduced compared to a traditional public offering.
More broadly, the SEC has emphasized creating more streamlined paths for smaller companies to raise capital.
In addition to Regulation A+, the SEC has recently adopted Regulation Crowdfunding, which permits issuers to raise up to $1 million in a 12-month period, adopted amendments that update intrastate offering exemptions to create additional flexibility for companies to use web-based platforms, and amended Rule 504 of Regulation D to increase the aggregate offering limit in any 12-month period from $1 million to $5 million. These programs may assist clean and renewable energy companies to raise capital without relying on the traditional avenue of venture-capitalbacked private financing rounds followed by a traditional IPO, which has become an increasingly challenging avenue of capital formation in the wake of Solyndra’s collapse in 2011.
In addition, in recent years, clean and renewable energy companies have increasingly turned to creative, nontraditional ways of accessing the capital markets. For example, SolarCity has issued solar bonds to raise corporate debt for the company, but has done so by offering the bonds, backed by the company’s solar panel systems, directly to retail investors in registered offerings. Many clean tech companies have also turned to state and local infrastructure finance agencies to fund clean tech projects now that most of the 2009 subsidies are gone. These agencies can create state clean energy funds to invest in clean energy, or even state green banks, which combine public and private sector funds to finance affordable and long-term loans to clean and renewable energy ventures. Green banks, or green investments banks, are public or quasipublic entities established specifically to facilitate private investment into clean energy infrastructure.
As discussed above, early stage and/or private clean energy companies have had access to a growing pool of venture capital and seed funding. In 2016, however, global funding for early stage private clean energy companies dropped off to a certain degree. Although a strong fourth quarter helped to stabilize investments for the year, funding in 2016 constituted a drop-off to the recent funding growth trend.
In addition, the number of exits by clean energy companies, which include IPOs and acquisitions, were also projected to drop in 2016. Although there have been approximately 30 clean energy-related IPOs since 2012, activity in this space has fallen off somewhat recently. After 127, 211, and 219 exits in 2013, 2014, and 2015, respectively, only 178 exits were projected for 2016 as of the third quarter, representing a decline of 20%.
Much of the weakness in 2016 resulted from the uncertain regulatory environment for clean energy companies as a result of challenges to President Obama’s 2015 enactment of the CPP, which aimed to set limits on carbon dioxide pollution. The CPP was litigated, as discussed above, and in February 2016, the U.S. Supreme Court ordered a stay of the enforcement of the CPP until a formal judicial review could occur. In September 2016, the U.S. Court of Appeals for the District of Columbia Circuit heard arguments challenging the constitutionality of the CPP. No decision has yet been announced, creating a level of uncertainty for clean energy companies. In addition, on March 27, 2017, President Trump issued an executive order directing the EPA to review the CPP, which is widely expected to lead to rolling back or revising the CPP.
Funding by sector can be extremely variable by year. For example, in the aftermath of Solyndra’s collapse in 2011, funding to solar companies fell by 50% from 2012 to 2013. In 2014, however, funding to solar companies rose again before dropping off in 2015. On the other hand, the wind sector has been a relatively stable growth sector, posting three consecutive years of growth from 2012 to 2015 and seeing funding increase tenfold over that timeframe. Funding to wind companies, particularly early-stage funding, continued at a steady pace in the early part of 2016.
Clean and renewable energy companies face the typical host of issues in connection with seeking and obtaining equity and debt financing from public and private sources. The following identifies and discusses a number of items that counsel should consider.
Regulated Nature of Business
The regulated nature of clean and renewable energy businesses often adds a layer of complexity to the due diligence process. Consequently, the time allotted for due diligence should be extended to match the level of familiarity of the investor with the particular clean and renewable energy segment. As an example, for a business that will be impacted by production tax credits (PTC), investors will want to be familiar with the current and expected status of the PTC. For companies that monetize Renewable Identification Number Credits or Solar Renewable Energy Credits, the status and operation of those markets will be important in addition to the core business of the company. Companies raising capital should be ready to educate potential investors on the regulatory environment as part of the due diligence process. Knowledge of the existing regulations is important, but so is an understanding of where the regulatory environment is likely to go in the future. Investors are investing in the current regulatory environment but will still be invested in the future if it changes and are likely to be more comfortable investing in a company that understands the current as well as the expected future environment. As companies develop past the initial stages, their technology advances, and the business model crystalizes, there is typically more due diligence on those matters. The complexity of the technology and business model will affect the speed at which investors get comfortable supporting the company, and any capital raising plan should plan for an appropriate length of time.
Companies should also understand whether there are likely to be any restrictions on foreign investment in their company. The Committee on Foreign Investment in the United States (CFIUS) oversees investments in U.S. assets that could affect national security. An investment from a non-U.S. party could be subject to review by CFIUS to the extent a company’s technology connects to national, state, or local electricity grids; supplies the defense industry; or has government contracts, among other factors. While review itself is not fatal (the committee allows the vast majority of transactions to proceed), review will take time and so counsel should be alert to the issue and plan accordingly.
Companies typically raise money when they need it, so the timeline to close on any new funding matters. The typical process of business due diligence, technical due diligence, and legal confirmatory due diligence can be stalled at any point. Being prepared internally for the process can make the last part, the legal due diligence, go more smoothly. This entails collecting documents likely to be requested in a due diligence process, reviewing them, and organizing them. The internal team should be looking to identify the same items as would external counsel. Among other items, the process is designed to confirm the capitalization, confirm ownership of the intellectual property, identify any third-party consents, and identify any activities that might give rise to liability (e.g., indemnities to third parties, arrangements with distributors and agents operating internationally, exclusivity, rights of first negotiation, non-competition, and most favored customer arrangements). Internal counsel should also be prepared to address the status of any existing, pending, or threatened litigation or investigations.
For both public and private companies, counsel must identify whether shareholder approval is required and obtain such approval and any other required third-party approvals early in the process. For a private company financing, a new series of preferred stock financing will typically require approval by the shareholders as a group, but also approval of individual series of investors. It is important to understand the required vote and the parties that will control or influence the vote. Early identification of the existence of investors with veto or blocking rights, by virtue of the number and type of shares held or contractual rights, will allow the internal team to ensure such investor is in favor of the financing and its terms. This can be important when the economic terms are not favorable to the company’s prior investors (either because it is a down round or the new investor demanded preferential rights). In addition to required votes, many investors in private companies will have the right to participate in any new round of financing. While that may seem like a good problem (if current investors want to participate), it can be difficult if a new investor is demanding a fixed percentage of the company following its investment and additional investment by others would dilute that interest.
In-house counsel must have a good understanding of the various regulatory regimes that impact the company’s business. Outside counsel can be relied upon for advice, but as the first line of inquiry from the internal client, internal counsel should have a broad overview and understanding of the various regulatory schemes within which the company operates. In addition to understanding the regulatory environment, understanding (to the extent possible) how other companies in the same market segment comply with their regulatory requirements can also be helpful. Sharing practices can allow in-house compliance and legal counsel to benefit from an additional thought process on how to deal with an issue or circumstance faced by the industry as a whole.
Accessing the Public Markets
Companies accessing capital from the public markets should prepare well in advance of when the capital will actually be needed. Companies may want to time the market to take advantage of interest rates, interest in particular industry sectors, or regulatory developments. Each time securities are offered, there is a due diligence process and a disclosure process. Compared to an IPO, the process in subsequent offerings is typically faster because it builds on what was previously done. However, for companies that expect to be in the market and their counsel, it is a good idea to maintain updated data room files in an organized fashion where new documents are easily identifiable. It is also a good idea to have established internal sign-off procedures to ensure material information is communicated to the deal teams and that representations and warranties can be provided to underwriters, lenders, and other relevant parties. Companies that are consistently in the market should create an internal team, create the appropriate processes and procedures, and keep materials organized so that the legal process does not interfere with the fundraising. It is also common for a company to use the same counsel for itself on each financing and to also designate underwriters’ counsel. Using the same external teams will also reduce the transaction time and expense as the teams build up the institutional knowledge and are not starting from the beginning for each transaction.
Scott A. Anthony is a partner in Covington’s Silicon Valley office. He advises public and private companies, investment funds, and entrepreneurs on mergers and acquisitions, venture capital investments, strategic investments, joint ventures, and other transactional matters. His clients include internet, social networking, online gaming, clean technology, software, networking and communications, semiconductor, energy storage, and life sciences companies. Eric Blanchard is a partner resident in the firm’s New York office and is a Vice Chair of the Securities & Capital Markets practice group. Mr. Blanchard’s practice focuses on domestic and international capital markets transactions, as well as governance, securities law reporting, and compliance. Mr. Blanchard has worked on securities offerings involving issuers from a variety of industries, from life sciences and technology to retail and consumer goods. In addition, Mr. Blanchard has represented both issuers and shareholders in proxy contests and shareholder activism matters. Matthew Gehl is special counsel in the firm’s New York office and a member of the Corporate Practice Group. He practices corporate and securities law, with a focus on the representation of underwriters and issuers in equity and debt capital markets transactions. He also advises clients on disclosure and other securities laws issues, corporate governance matters, and other general corporate matters.
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