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The Current: Term Sheets and Closings – 10 Things to Remember

Published by Forrest D. Milder on Sunday, July 1, 2012

Journal cover July 2012   Download PDF

I thought it would be appropriate this month to step back a bit from pure tax and grant issues and consider one of the most important parts of developing a renewables project: negotiating the term sheet and getting to closing. Here’s a quick review of 10 of the most important considerations:

  1. Make sure you like who you are dealing with. The first thing to remember is also the most important! Thankfully for developers, the biggest investors in this space seem to be excellent companies to work with. Still, the parties will likely be partners for at least five years, if not as many as 20 or more, and that’s a long time to be paired. So, make the effort to get to know the other side: the particular people who will be responsible for the investment, as well as their professional advisors.
  2. Have realistic expectations. Sometimes the facility is about to be placed in service, or there are other reasons for compressing the closing time line. But understand that these deals are rarely “cookie cutter” and that all the requirements of closing a tax equity investment can take time. It’s important to get the transaction done correctly, so don’t insist on a “fire drill” mentality without good reason. You really don’t want to rush to a closing only to find out later that mistakes were made, or document provisions were not well thought out.
  3. Comply with tax rules. Make sure that you review the tax sensitive provisions with your professional advisors. You may set out to have allocation, capital account or exit provisions that reflect the parties’ desires in a simple and straightforward fashion, only to find that complex tax rules get in the way. It’s a good idea to find that out now, and not when you are a week from closing. Now is also the right time to ensure that you haven’t missed important technical rules, like the tax consequences of related party debt, the effect of general partner guarantees on the allocation of tax benefits, and so on. The application of these rules can vary widely from transaction to transaction, so don’t just assume that what you did previously will work this time.
  4. Plan exit strategies. These are especially important. Both the developer and the investor may be happy to have the investor depart for a dollar one day after the recapture period ends, but there’s a good chance such a strategy won’t comply with the tax rules. And, different tax advisors have different views of puts and calls; many impose fairly specific conditions before they can be used, and some avoid puts altogether. If an opinion will be required, this is an important time to assure that the responsible legal team is prepared to opine that your format is acceptable.
  5. Conduct due diligence and make a closing checklist. Establish early in the process what the investor’s team will require in order to close, and get those materials and documents organized and ready to supply as soon as possible. If you are trying to close quickly, advance preparation can save a lot of time. Of course, there is no reason why everyone can’t work on multiple fronts at the same time — developing the financial model, getting engineering reports and insurance coverages and negotiating the deal documents. Still, don’t be surprised if the investor restrains its legal team if it senses that some part of the closing checklist is unduly stalled.
  6. Understand the role of other professionals. Many transactions need multiple specialists and experts: an appraiser to justify the size of a lease-pass through credit or grant, engineers to approve placement in service, accounting specialists to produce a tax benefit and cash-flow model, and others. Track down who you will be using, make sure that they are acceptable to the other side, and assure that they are prepared to close on your timetable.
  7. Learn how to deal with the lenders. Of course, lenders will have their own set of closing requirements, and they’ve got to work together with the rest of the team. One significant point where the lender and the tax-equity investor come in contact is the so-called “non-disturbance” agreement. Investors will seek the best assurance they can get that the lender won’t appear on their doorstep during the tax credit vesting period, threatening to foreclose on the property in a way that could cause recapture. Lenders will resist giving too much on this point. It’s important to get the parties to agree as soon as possible, in order to avoid a last-minute blowup that could delay the closing.
  8. Consider cash obligations and guarantees. The developer should review carefully the guarantees required by the investor. They may come in the form of pledged property or letters of credit, a “deficit restoration agreement” (to contribute cash on liquidation if required), or other features. Be sure that you are content with what the investor is expecting of you, and that you have sufficient confidence in your facility and your assumptions that you think a draw on the support that you are providing is unlikely. Finally, the developer should try to get favorable adjustments made as the risks of the deal are reduced. For example, consider a credit facility that might accompany a guarantee against investment tax credit recapture. It may make sense for this to decline in amount as the five-year vesting period elapses.
  9. Check the math. The term sheet will likely provide more than one flow of funds – when you can expect payment of development and management fees, how the parties expect to share any excess cash flow, the distribution of refinancing or liquidation proceeds, and so on. Make sure now that these cash flows make sense, and that they all work together. Otherwise, you may find yourself renegotiating the deal on the eve of closing, or worse, sometime after the facility is placed in service!
  10. Discuss financial reporting and preparation of tax returns with your accountant. The term sheet will include requirements for producing timely tax returns and financial reporting, and it may describe significant penalties if the deadlines for producing these materials are not met. Be sure to review these requirements and penalties with your accounting team to assure that the expectations are reasonable and consistent with what you can provide.

Attention to these suggestions can be important to getting to as quick and smooth a closing as possible, while also limiting surprises down the road.

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