Joint ventures provide a winning formula for downstream investment

Kay Hobbs, partner at the law firm TLT, discusses the growing prevalence of joint ventures between developers of and investors in clean energy projects and the various forms these can take.

Green energy projects have always been viewed as a safe investment, but in order to adapt to a market of changing technologies and increased competition investors are having to look at different routes to market.

To explore this further, established technologies such as wind or solar – backed by a subsidy that provides guaranteed revenue streams – are still seen as the golden goose of investment. However, the majority of these assets have been consolidated into portfolios that rarely come to market, and when they do, competition is fierce.

That may change as these assets come to the end of their FiT/RoC accreditation, but asset life extension and the associated upgrade of the technology can considerably extend the life expectancy of an operational asset. This means that for the short to medium term at least, these portfolios could remain on the shelf.

Newer technologies, such as energy storage or subsidy-free solar/wind, and multi-technology projects that combine solar or wind with energy storage as a future-proofing mechanism, have attracted increased investor interest. Why? Because if you take subsidy-free solar or wind as an example, while the risk associated with subsidy-free revenue streams may be higher, the technology itself is still known and trusted.

Despite the dramatic reduction in subsidies in the sector, investor interest has continued to steadily increase. This is no doubt because the UK is generally seen as a stable territory for investment and the UK has a skilled workforce to deliver projects. It is also down to the UK’s net zero ambitions and the increased focus on ESG investment.

All of this has meant that there is more capital vying for the same projects, and this increased competition is causing investors to revise their investment strategies to look at other opportunities – one of these being downstream investment.

The perfect match

The last 18-24 months have seen a dramatic increase in investor/developer joint venture (JV) arrangements where one party has the development expertise and the other has funds to invest. This mirrors what we have been involved with at TLT, and over the last 24 months more than  a third of transactions have involved this model.

The question therefore is how do you create downstream investment business models that work for both parties, and how do you achieve the collaboration needed to make these JVs become real partnerships?

Before considering the best route to structure the JV – be that equity shares or a more innovative approach, such as profit-sharing arrangements – there needs to be a real synergy between the investor and the developer. What that means in practice is the investor needs to commit more than just the funds, and the developer needs to be incentivised to create high returns on projects and deliver on the project pipeline.

For the investor, that means choosing a development partner with experience of the technologies they are proposing, who is organised, has a market reputation for delivering successful bankable projects without cutting corners, and can demonstrate well thought-out and future-proofed project structuring and modelling. For example, with investors now looking at 40-year lease terms for solar and battery storage projects, a development partner should be aware of and build into the project these market changes in order to make their projects investable.

For the developer, it’s about finding a funding partner that shares the same vision in terms of future pipeline growth (and is committed to funding such growth) and who will afford them sufficient flexibility within agreed parameters to develop a portfolio (e.g. the developer isn’t required to come back to the investor to approve every last decision or £1 of spend).

Choosing the right model

The most traditional JV model is one where both the investor and the developer hold equity in a holding company that, in turn, owns the individual project special purchase vehicles (SPVs). The developer is engaged (sometimes under a separate development services agreement) to find, present and develop those sites that are accepted into the JV.

There are many variables that can be tailored to the bespoke arrangement between the two parties, such as their stakes; who’s funding what (some developers want to retain the ability to part-fund); funding provision; who’s controlling what in terms of decision making; what each party’s return will be and when returns will be extracted.

While there will be similar concepts across most corporate JVs, the documentation will to a large extent be bespoke and tailored to the actual relationship and commercial principles agreed between the parties. It is therefore key for both parties to seek their own legal representation from advisors that are well experienced with these types of arrangements in this sector, to ensure the documentation secures the best position possible for them and de-risks and main exposure.

Other JV models can include:

• A forward-funding model whereby the investor makes funds available to the developer for certain projects, with a legal right to take the project when certain milestones are achieved (e.g. planning granted). This can be a good way for an investor to secure a continual pipeline of projects. However, it is only likely to be attractive from an investor perspective if forward-funding is provided on a portfolio basis (i.e. to de-risk site failure) and if the developer can provide security over the funded assets (and possibly other assets, depending on the level of exposure to the investor).
• A commercial exit framework arrangement, whereby an investor agrees to purchase a project that meets certain criteria at a certain milestone for a pre-agreed price on pre-agreed terms. This can help the investor secure a stream of projects from a developer (thereby locking out any competition), while giving the developer certainty as to an exit at a guaranteed price. It can be a cost-effective way for both parties to buy and sell projects instead of having to buy/sell multiple projects with multiple buyers/sellers – because the same suite of documents can be used each time.
• A commercial profit share arrangement, whereby a developer transfers ownership of a project to an investor in return for a contractual share of the profits, rather than an equity stake. We have seen this more in respect of where a landowner has developed a project itself.

With the right arrangement in place, both parties will be fully incentivised to work together and the relationship will flourish, which in turn will result in a really strong partnership and a successful portfolio development. Bringing together the necessary skills and the necessary funds can have a lot of potential, but it’s imperative to find the right partner and to get the documentation right from the outset. Otherwise, the partnership may be doomed to fail.

Green energy generation and grid balancing will play a critical role in the UK achieving its net zero targets, and successful JVs can play a significant role in achieving that, particularly where opportunities are not yet able to attract traditional debt finance. We expect to see a continued increase in developers and investors teaming up in the months, and years, ahead.