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By: Scott Anthony, Eric Blanchard, Matthew Gehl and Sarah Griffiths, Covington & Burling LLP
This guide covers all related information that a securities practitioner needs when working with a clean and renewable energy company. It provides an overview of the industry and covers applicable securities laws and regulations, securities offering process, disclosure and corporate governance obligations, stock exchange requirements, commercial and regulatory trends, and practical tips for counsel.
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 that went public in 2007; BioAmber Inc., which sells a biologically produced, chemically identical replacement for petroleum-derived succinic acid, and who completed their 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 be paid 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 below under Startup Financing). Major financing rounds from 2016 have included $1 billion in Series A to WM Motors (Chinese electric vehicle), $120 million in 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 provide the framework for securities regulation are the Securities Act of 1933, as amended (Securities Act), and the Securities Exchange Act of 1934, as amended (Exchange Act). 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.1
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 liability 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.2
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.3
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),4 or an unlimited amount subject to limitations on the type of permitted investor (Rule 506).5 Rule 144A6 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 S7 is a safe harbor utilized for offerings made exclusively outside of the United States.8
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.9 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 40510 under the Securities Act and Rule 3b-411 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.12
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.14
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.15
As with companies in most other industries, clean and renewable energy companies must conduct both debt and equity offerings in the United States in accordance with the Securities Act, which requires that the offer or sale of a security be registered with the SEC or fall under certain enumerated exemptions.
A public offering requires filing a registration statement with the SEC covering the securities to be sold. Before a registration statement has been filed, the issuer and underwriter cannot make offers to or solicit offers from prospective buyers, and before the registration statement has been declared effective by the SEC, the issuer and underwriter cannot sell securities.
Typically, the process for registered public offerings begins by selecting an underwriter, holding an organizational meeting with the primary working group (the issuer, issuer’s counsel, the underwriters, underwriters’ counsel, and the issuer’s auditors), and beginning to jointly prepare the registration statement and prospectus. The working group may include additional third parties, including regulatory and industry-specific consultants. The organizational meeting will typically include an expected timeline for the offering, including targeted dates for filing the registration statement and preliminary prospectus and for pricing the offering.16
The primary transaction document is the underwriting agreement, which sets forth the terms and conditions under which the underwriters purchase the securities from the issuer and offer them to investors. The underwriting agreement contains representations and warranties by the issuer, which assist with the underwriters’ due diligence (as discussed below) and help allocate risk between the parties. It also includes issuer covenants, closing conditions, and indemnification and contribution obligations. In registered debt offerings, there is also an indenture, which governs the terms of the debt securities, and issuers must select a trustee to act as the representative of the debt holders and as registrar, transfer agent, and depositary under the indenture.
In an underwritten offering, the underwriters are compensated through an underwriting spread, which is the difference between the amount the underwriters pay for the securities and the price at which they sell the securities to the public. The standard underwriting spread across all industries for an IPO of equity securities is 7%, while the median underwriting spread for a followon equity offering is less standardized, often ranging between 4% and 6%. Underwriting spreads for issuances of debt securities vary depending on the type of debt security offered and the credit rating of the issuer but are typically lower than the underwriting spread for equity offerings. Underwritten equity offerings also usually include an underwriters’ option to purchase additional securities (typically 15% of the principal amount) at the initial purchase price, which is known as a greenshoe or an overallotment option. This option allows the underwriters to stabilize the price of the securities in the open market.17
The Securities Act imposes liability on both the issuer and the underwriter for, among other things, material misstatements or omissions in the registration statement or prospectus. For this reason, the parties rigorously investigate the issuer’s business and financial operations in due diligence and carefully and comprehensively review the registration statement and prospectus. The due diligence investigation provides support for the disclosure in the registration statement and prospectus and protects the underwriters from liability if they can establish that a reasonable basis existed for their belief that the registration statement was accurate and complete.
As part of the due diligence process, the underwriters and their counsel will request documentary due diligence materials and backup for disclosure in the registration statement. A typical offering may involve intellectual property or regulatory lawyers as part of the due diligence process. Usually in an IPO, and often in other offerings as well, due diligence may also include conversations with the issuer’s suppliers, customers, and collaborators. Counsel for the issuer and underwriters will negotiate the underwriting agreement as well as certain other transaction documents, such as lock-up agreements, legal opinions, and a comfort letter from the auditor. In addition to legal opinions from its primary corporate counsel, an issuer may be required to provide legal opinions from counsel handling regulatory, intellectual property, tax, litigation, or other matters for the issuer. The parties will also prepare a suite of standard closing documents and certificates.18
In a registered offering, the primary offering documents are the registration statement and the prospectus. The registration statement includes the prospectus and is filed with the SEC. The prospectus is delivered to purchasers and contains extensive disclosure about the issuer’s business and financial operations, as well as information about the offering. The registration statement is filed with the SEC, and the SEC will typically review and provide comments that must be addressed before the registration statement is declared effective (unless the registration statement is automatically effective, as discussed earlier). Depending on the details of the transaction, filings with FINRA, Nasdaq, or NYSE, and state or blue sky filings may also be necessary. Once the registration statement is effective, the issuer and the underwriters settle on a price for the transaction, sign the underwriting agreement, and begin sales to investors. Typically, the closing date is T+3, or the date that is three business days from the date of the underwriting agreement. From start to finish, in many cases, an IPO of equity may take from four to six months to complete. It can take much longer depending on market conditions, SEC review, and other factors. A follow-on offering of equity or an offering of debt can take anywhere from several days to several weeks to complete, absent complications.19
Advice for Issuers
An IPO, including due diligence, is a very intensive process. Internal and external counsel should prepare in advance as much as possible. Having due diligence and other documentation organized in advance will streamline the process and allow for faster drafting of relevant portions of the registration statement. In addition, the structure of the board of directors is likely to change in an IPO. Having the post-IPO board in place will prevent last-minute disclosure revisions caused by changes in the board composition. If possible, determine the board composition and complete all background checks and director questionnaires early on. Identifying an issue with a director during the process will cause time to be lost while the team works on a solution. Prepare employee stock option and stock purchase plans and descriptions as early as possible. Collect all of the executive compensation information so that it can be readily described. The IPO should be about the company telling its story. The work to develop and refine that story should not be adversely impacted by counsel and other advisors being distracted with implementing corporate governance changes.
An alternative to a registered offering of securities is a private placement. The main advantages of a private placement are that it avoids the significant costs of the registration process and does not require the issuer to become a reporting company under the Exchange Act. To qualify for a private offering exemption (which is discussed in more detail above), however, issuers must comply with limitations on the manner and form of the offering, including restrictions on the types of investors who can participate in the offering or the amount of capital that can be raised.
In a private placement, no SEC registration statement filing is required, but usually the overall offering process is generally similar. Issuers often select a registered broker-dealer to serve as a placement agent and assist in finding potential investors. Rather than a prospectus, the working group prepares an offering memorandum or private placement memorandum that includes information about the issuer’s business and financial operations, and rather than an underwriting agreement, the issuer enters into a purchase agreement (or several purchase agreements with individual investors) that set(s) forth the terms and conditions of the sale of securities. The issuer may need to make certain filings (for example, a Form D if relying on Regulation D), and may also have Form 8-K or other Exchange Act filing or disclosure obligations as a result of the financing.20
Earlier-stage clean and renewable energy companies often rely on private seed and venture capital financing to raise capital. Because companies in this industry usually require a long period of time before they reach profitability and thus rely on regular infusions of capital to grow their businesses, they often go through the typical start-up venture capital financing life cycle.
The first stage of start-up financing is referred to as seed financing and usually consists of financing from friends and family or specialist investors known as angel investors who invest in early stage companies. Seed financing typically includes the purchase by the investor of convertible preferred stock including rights such as a liquidation preference (priority in receiving proceeds from a sale or liquidation of the company) and protective provisions (veto rights over certain corporate actions). Seed financing can also take the form of convertible notes, which are debt securities that accrue interest and covert into equity securities upon certain specified events (e.g., a preferred stock financing, IPO, or a sale of the company). When a conversion event occurs, convertible noteholders typically receive equity at a lower price than that paid by new equity investors. Seed financing can also consist of common stock or simple agreements for future equity (a contractual agreement that has many of the same features of a convertible note). Because of the early stage nature of seed financings, they do not typically involve an intermediary such as a placement agent. A company may undergo multiple rounds of seed financing.
The next stage of financing is often described as Series A financing and involves raising capital from professional institutional investors, including venture capital funds. Significant venture capital investors in the clean and renewable energy space include Kleiner Perkins Caufield & Byers, Khosla Ventures, and Braemer Energy Partners. Series A financings typically consist of the purchase of convertible preferred stock. In addition to a liquidation preference and protective provisions, Series A preferred stock can also include anti-dilution protection, rights to a board seat or a nonvoting board observer, demand, piggyback and shelf registration rights, rights to participate in future offerings, and drag-along rights. These rights are documented in a stock purchase agreement, a restated certificate of incorporation, and an investor’s rights agreement. This stage of financing usually also does not involve a placement agent.21
Following Series A financing, companies usually pursue additional rounds of venture capital financing (Series B, Series C, etc.) with similar characteristics as Series A financing. Later rounds of financing are increasingly likely to include placement agents and take on more of the characteristics of a public offering (e.g., a more detailed disclosure document including sections on business and risk factors, larger working groups, and broader marketing efforts). Later rounds of financing may also include warrants to purchase additional common shares as a sweetener in anticipation of an IPO or a sale of the company.
It is important to keep the private placements private and to have good records of the sales of unregistered securities. As part of any later-filed public registration statement, a company will have to describe all sales of unregistered securities for the three years prior to the sale. A company with good records of its private placements can provide the information without concern. When issuers do not keep clear records, it can be difficult to deal with any questions from the SEC regarding the sales of securities prior to the IPO. Restricting the number of nonaccredited investors (keeping it at zero where possible), obtaining proper certifications from investors, and tracking the investors and potential investors to whom information was distributed (e.g., by numbering offering materials packets and keeping a log of which investors get materials) will make retracing the company’s actions significantly easier.22
Depending on whether a clean and/or renewable energy company is a domestic U.S. issuer or an FPI, the SEC requires the issuer to disclose different qualitative and quantitative information in its registration statement or prospectus. These disclosure requirements, which are generally standard and do not require different categories of information for different industries, can include the following:
The federal securities laws and regulations currently require that an issuer disclose the most significant factors that make an investment in its securities speculative or risky. Such disclosure is meant to be specific to the issuer and should not cover risks that could apply to any issuer or any offering. Typically, clean and renewable energy companies focus this risk-related discussion on three broad categories: (1) the use of relatively untested technology that may be difficult to commercialize, (2) dependence on tax and related government incentives, and (3) potential product liability claims. Each type of clean and renewable energy company should also discuss in detail risks related to its regulatory oversight. For example, an alternative fuel company may wish to describe any issues it has encountered related to compliance with regulations that govern the use and disposal of hazardous materials.
A good starting point for drafting risk factors is the disclosure of comparable companies in the space. Public companies will have reviewed their businesses and identified risks. Such disclosures will need to be evaluated for applicability to the current business (by the legal, finance, or other appropriate business teams) and then adapted to the specifics of the company. To the extent there are additional business lines and other differences between the precedent and the company, other risk factors should be added. The process of reviewing another company’s risk factors is also likely to identify other risks in the company’s business that should be described.23
Additional guidance on risk factors and examples of disclosures of risk factors from clean and renewable energy companies can be found in the complete practice note, Clean and Renewable Energy Industry Guide for Capital Markets.
MD&A and Business
Because of the capital and technology-based hurdles that clean tech companies’ face, federal, state, and local regulatory authorities have robust programs for funding or incentivizing the research and operations of this industry. Many clean and renewable energy companies rely on government incentive programs to support their operations, whether in the form of direct payments, rebates, tax credits, or otherwise. Because of the importance that such programs play in the business and financial operations of many clean and renewable energy companies, counsel should carefully consider how to describe such programs in the business and MD&A sections
For these issuers, it is market practice to weave this discussion throughout the entire disclosure document, noting it carefully in the risk factors, MD&A, and business section. This disclosure helps to provide investors with a full view of the potential risks and rewards facing the clean and renewable energy industry. Although government incentives are available, the process for acquiring such incentives can be incredibly complex, fragile, and uncertain. As a younger industry than others (for example, financial services and life sciences), the clean and renewable energy industry must include disclosure in its documents that can be more involved than simply finding a handful of acceptable precedents. Instead, each company can face a completely different set of regulatory hurdles and benefits, necessitating additional and unique disclosure. Furthermore, these regulatory requirements may vary across jurisdictions.24
Additional guidance on and examples of MD&A disclosures from clean and renewable energy companies can be found in the complete practice note, Clean and Renewable Energy Industry Guide for Capital Markets.
Counsel should also consider the appropriate accounting treatment of government incentive programs in the issuer’s financial statements as well. For instance, many clean and renewable energy companies receive tax credits and rebates, and there is no authoritative accounting treatment for such incentive programs under U.S. GAAP. Issuers have a variety of ways to characterize such programs in their financial statements, including treatment as revenue, as reduction to expense, or as income tax benefit. How such programs are characterized may play a significant role in an issuer’s revenue recognition, especially with respect to timing and depreciation. The appropriate treatment of such programs will vary based on the purpose and nature of the incentive program, and counsel should coordinate with the issuer and its accountants to ensure that the bases for the issuer’s chosen accounting treatment are accurately and fully described in MD&A.25
Additional guidance on and examples of accounting disclosures from clean and renewable energy companies can be found in the complete practice note, Clean and Renewable Energy Industry Guide for Capital Markets.
Other Governmental Incentives
Other government incentive programs may not be reflected in an issuer’s financial statements under U.S. GAAP because they have no direct effect on its financial statements. For instance, there are a number of governmental incentive programs that provide tax credits to consumers who utilize certain clean and renewable energy technologies, such as the use of alternative fuels in motor vehicles or expenditures on residential or commercial solar energy systems. However, because such tax credits are claimed by the end-user customer and not by the issuer, these programs are not recorded in an issuer’s financial statements. They may exist at all of the international, federal, state, and local levels and consist of dozens of distinct programs with distinct characteristics. Nonetheless, because such programs may remain material to an issuer’s business and results of operations, counsel should ensure that they are described accurately and completely.26
Finally, while issuers are often well aware of the necessity of disclosing the risks associated with changes to government incentive programs in the risk factors section, similar disclosure is also often necessary in the MD&A section. The SEC views MD&A as providing investors with “a look at the company through the eyes of management.” Because of the importance of the rapidly changing and multifaceted regulatory environment surrounding government incentive programs to most clean and renewable energy companies, counsel should ensure that the MD&A section similarly reflects a full discussion of any government incentive risks and uncertainties. Item 30327 of Regulation S-K requires issuers to disclose currently known trends, events, and uncertainties that are reasonably expected to have material effects, as well as known uncertainties that are less than trends but may nonetheless result in material consequences to an issuer’s results of operations. As such, issuers should also include appropriate disclosure in MD&A reflecting potential regulatory changes, changes in government incentive programs, and known shifts in consumer trends that may affect the business.
Additional guidance on and examples of governmental trends and incentive disclosures from clean and renewable energy companies can be found in the complete practice note, Clean and Renewable Energy Industry Guide for Capital Markets.
Other Prospectus Disclosure
In addition to specific risk factors on untested technology, difficulty commercializing, and the potential lack of adequate product liability insurance, separate disclosure is often necessary to help define for investors what the issuer’s key operating data or metrics include, given the nature of clean and renewable energy issuers’ operations. For example, in Clean Energy Fuels Corp.’s IPO prospectus, the company disclosed the number of fueling stations served and gasoline gallon equivalents delivered, while SolarCity, in its IPO, described the number of new buildings served and the megawatts booked and deployed in its relevant financial period as its key operating metrics. This disclosure is often prominently displayed in the summary or selected financial statements in the body of the disclosure document, and is where both Clean Energy Fuels Corp. and SolarCity chose to disclose it. Because these metrics are non-GAAP measures, however, clean and renewable energy companies choosing to discuss such key operating metrics should ensure that the disclosure and presentation of these figures complies with Item 1028 of Regulation S-K, Regulation G29, and SEC guidance relating to the use of non-GAAP financial measures. For example, in May 2016, the SEC released a series of Compliance and Disclosure Interpretations directed at the use of non-GAAP financial measures.
Requirements for the disclosure of non-GAAP information have existed for a number of years, but have only recently been the focus of the SEC. The focus of the SEC evolves over time and it is a good idea to stay abreast of the current focus. SEC comment letters are public and there are reports that compile the comment letters and identify trends. Such reports can be useful tools for both inside and outside counsel to stay abreast of developing trends and to identify potentially new areas of focus and for disclosure.30
Additional Disclosure Issues
The Sustainability Accounting Standards Board (SASB) is a nonprofit organization that has developed sustainability accounting standards and seeks to integrate its standards into public company disclosures. SASB recently issued accounting standards for the renewable resources & alternative energy sector, which it defines as companies producing solar and wind power systems, fuel cells and batteries, biofuels, timber, and pulp and paper products. The standards include disclosure guidance and accounting standards on sustainability topics that may constitute material information. Sustainability issues are coming increasingly into focus across all industries, and in particular in the energy industry. Disclosure around sustainability topics may become particularly important for clean and renewably energy companies both as a matter of public expectation and as a means for differentiation from other types of energy companies.
Public and private securities offerings in the United States are generally made through a syndicate of underwriting banks, led by one or more lead underwriters. The underwriting agreement defines the relationship between the issuer and the underwriters by allocating the risks related to the offering and defining the formal commitment of each of the banks. Underwritten offerings are usually on a firm commitment basis, which means that the underwriters take on the full risk of the offering by committing to purchase all of the securities that are being sold to the public. As an alternative, a best efforts underwriting allows an underwriter to only use best efforts to sell the securities rather than purchasing them all for their own account and then reselling, thus creating some risk for the issuer that it may not raise the full amount of desired proceeds.
Most investment banks that act as the lead underwriter have a preferred form of underwriting agreement. However, the terms of a bank’s form of underwriting agreement may be negotiated to suit the specific facts and circumstances surrounding an offering. In connection with an offering by a clean and renewable energy company, the most commonly negotiated provisions of an underwriting agreement will likely be the representations and warranties of the company. The representations and warranties contain certain statements of fact and assurances by the company, and they confirm the accuracy of the information provided to investors (either in the registration statement or offering memorandum). In addition, they also focus the due diligence investigations of the underwriters. Many of the representations and warranties provided by a company will be standard across industries. However, certain representations and warranties included in the underwriting agreement should be tailored to reflect the situation of an issuer. For example, it is common for companies to negotiate representations and warranties related to the following: (1) possession and maintenance of material intellectual property rights necessary to conduct business; (2) compliance with applicable regulatory laws; (3) possession and maintenance of all necessary licenses, permits, and regulatory approvals to conduct business; and (4) compliance with environmental laws, which may include laws related to the disposal of hazardous materials.
Additional guidance on and examples of representations and warranties in underwriting agreements from clean and renewable energy companies can be found in the complete practice note, Clean and Renewable Energy Industry Guide for Capital Markets.
There are few continuous disclosure and corporate governance requirements that apply to clean and renewable energy companies aside from the standard corporate governance requirements promulgated by the SEC and securities exchanges. One topic that clean and renewable energy companies should carefully consider is the corporate governance principles applicable to project finance vehicles. Many clean and renewable energy companies use structured special purpose vehicles (SPVs) to obtain debt or equity financing for the development of individual projects. Companies (referred to as sponsors in the context of creating an SPV) use SPVs to isolate the assets of the project finance vehicle and remove them from the bankruptcy risk of the sponsor. However, the use of SPVs by clean and renewable energy companies raises a number of corporate governance and disclosure issues above and beyond the off-balance sheet arrangement disclosure which requires a separate caption and discussion in MD&A. Notwithstanding the emphasis on the nonconsolidation and separateness of an SPV with its sponsor, including the transfer of the assets of the SPV off the sponsor’s balance sheet, companies should ensure that their corporate governance policies and procedures provide adequate information regarding the operations of the SPV and its relationship with its sponsor to the audit committee and the board of directors.
For instance, many sponsor-SPV transactions will be considered to be related party transactions (due to, among other things, commonality of management), and companies should consider requiring their audit committee to, in consultation with their legal counsel and auditors, review and approve all transactions between the sponsor and an SPV. Nasdaq rules only require a review, not an approval, by the audit committee of related party transactions, and NYSE rules merely recommend, but do not require, audit committee review and approval of related party transactions. However, because of the importance of and potential for fraud related to transactions between a sponsor and its project finance SPVs, companies should consider adopting more stringent corporate governance policies and procedures and including appropriate disclosure in SEC filings.31
Additional guidance on and examples of SVP disclosures from clean and renewable energy companies can be found in the complete practice note, Clean and Renewable Energy Industry Guide for Capital Markets.
In addition to the conflict of interest rules, internal and external counsel should be particularly familiar with the disclosure requirements for Form 8-K and the reporting and short swing profits rules of Section 1632 of the Exchange Act. Form 8-K is the SEC form on which a company must report certain specified transactions or circumstances, including, among others, material agreements and officer and director compensation and changes.33 Understanding and tracking the Section 16 rules governing the ability of senior executives to trade in company stock is critically important to internal counsel charged with dealing with compensation issues or counsel that might be asked to advise on such a matter. The market closely tracks purchases and sales of company stock by insiders, and so it is important that reporting be done accurately and purchases and sales properly timed so as to avoid the executive having Section 16 violations.34
The major stock exchanges, including NYSE and Nasdaq, do not generally distinguish among different industries of issuers. Nevertheless, NYSE and Nasdaq do exempt FPIs from most of the relevant corporate governance requirements, allowing them to opt instead to comply with certain home-jurisdiction requirements. This is important as China continues to expand the volume of clean and renewable energy companies hoping to seek financing in the United States. For example, Chinese companies such as Solar Power, Inc. and Canadian Solar have recently expressed aspirations to attempt IPOs in the United States. Furthermore, Tongwei Group Co., a Chinese company that is building what would be the world’s biggest solar plant, also expressed strong interest in 2016 about conducting a U.S. IPO in the near future.35
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 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.
Additional guidance and information on regulatory and industry trends for clean and renewable energy companies can be found in the complete practice note, Clean and Renewable Energy Industry Guide for Capital Markets.
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. For example, for a business that will be impacted by the production tax credits, 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 and 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, noncompetition, 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 Anthony is a partner in the Silicon Valley office of Covington & Burling LLP. 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. Mr. Anthony also advises U.S. listed public companies and foreign private issuers on corporate governance and securities compliance issues. Eric Blanchard is a partner resident in the New York office of Covington & Burling LLP and 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 New York office of Covington & Burling LLP 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. Sarah Griffiths is an associate at Covington & Burling LLP and practices corporate and securities law, with an emphasis on international and domestic capital-raising transactions.
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1. For further information, see U.S. Securities Laws. 2. For further information on registered offerings as well as well-known seasoned issuers, see Follow-On Offerings Resource Kit, WKSIs and Seasoned Issuers, and Equity Offerings Comparison Charts. 3. For further information, see Liability under the Federal Securities Laws for Securities Offerings. 4. 17 C.F.R. § 230.504. 5. 17 C.F.R. § 230.506. 6. 17 C.F.R. § 230.144A. 7. 17 C.F.R. §§ 230.901–905. 8. For more information, see Private Placements Resource Kit, and Private Placement Considerations. 9. For further information, see Periodic and Current Reporting Resource Kit. 10. 17 C.F.R. § 230.405. 11. 17 C.F.R. § 240.3b-4. 12. For more information on FPIs, see Rule 12g3-2(b) Foreign Private Issuer Reporting Exemptions, and Foreign Private Issuers and Rule 12g3-2(b) Filing Exemption Checklist. 13. For further information on some of these topics, see Market Trends 2016/17: The Jobs Act and Emerging Growth Company Guide for Capital Markets. 14. For more information, see Document Submission to the SEC, Understanding the SEC Review Process, and NYSE vs. Nasdaq Disclosure Requirements. 15. For further information, see Blue Sky Requirements for Private Offerings, Securities and Transaction Exemptions under Blue Sky Laws, Blue Sky Memorandum: When and How to Use, and Blue Sky Law Compliance in Securities Offerings. 16. For further information, see Parties to a Securities Offering Checklist and IPO Key Agreements. 17. For forms of underwriting agreements in various contexts, see Underwriting Agreement (Primary Offering) and Underwriting Agreement (Combined Primary and Secondary Offering). 18. For further information, see Due Diligence Interviews, Accounting Due Diligence, and Due Diligence: Managing the Process for an IPO. 19. For further information, see IPO Time and Responsibility Schedule, and SEC Comment Letter Responses. 20. For further information and forms of documents, see Private Placement Memorandum Drafting, Private Placement Memorandum Form, Private Placement Memorandum (Hedge Fund Limited Partnership Interests) (DE), and Common Stock Subscription Agreement (Private Offering, Start-Up Company). For information on due diligence in a private offering, see Due Diligence for a Private Offering. 21. For a form of registration rights agreement, see Registration Rights Agreement. 22. For further information on issues that may arise with start-ups, see Rule 506 General Solicitation and Startup Capital-Raising, and Indemnification of Start-Up Directors and Officers. 23. For further information, see Risk Factor Drafting for a Registration Statement and Market Trends 2016/17: Risk Factors. 24. For further information on MD&A, see Management’s Discussion and Analysis Section Drafting Checklist. 25. For further information on accounting treatment and related issues generally, see Accounting and Auditing Professional Bodies and Standards. 26. For information on materiality, see Materiality Determination Guidelines and Determining Materiality for Disclosure Checklist. 27. 17 C.F.R. § 229.303. 28. 17 C.F.R. § 229.10. 29. 17 C.F.R. § 244.100 et seq. 30. For further information, see Market Trends 2016/17: Public Company Reporting and Corporate Governance and SEC Regulation of Non-GAAP Financial Measures — Drafting Disclosure Compliant with Regulation G and Item 10(e). 31. For a discussion of sponsors and related party issues in an IPO context, see Sponsor-Backed IPOs: Governance and Liquidity Issues. 32. 15 U.S.C. § 78p. 33. For further information, see Form 8-K Reportable Transactions and Filing Deadlines Reference Chart, Form 8-K Checklist, and Memorandum to Management on 8-K Triggering Events and Related Disclosure Reporting Procedures. 34. For further information, see Section 16(a) Compliance, Liability Calculations under Section 16(b), Section 16 Forms Filing, and Short Sale Prohibition under Section 16(c). 35. For further information on NYSE and Nasdaq, see NYSE and Nasdaq Director Independence Standards Chart, 20% Rule and Other NYSE and Nasdaq Shareholder Approval Requirements, NYSE Initial Listing Requirements Table, NYSE Continued Listing Requirements Table, NYSE Notification Requirements Chart, NASDAQ Corporate Governance Listing Requirements Table, Nasdaq Initial Listing Requirements Table, Nasdaq Continued Listing Requirements Table, and Website Posting Requirements Chart (SEC, NYSE, and Nasdaq).