[authors: Crayton L. Bell, S. Kiran Lingam]
As the regulatory and competitive risk profile of renewable energy/greentech companies has increased, so too has the use of earnouts or other deferred compensation structures in M&A transactions in this space, particularly in smaller- and middle-market transactions. Buyers have become increasingly concerned with (i) the prospect of reduction or elimination of government subsidies, (ii) the potential reduction or elimination of consumer incentives that support product demand (e.g., tax rebates for solar panel installation), and (iii) price pressure resulting from increasing supply (particularly with respect to solar) and low-cost, traditional energy sources (e.g., natural gas).
This trend seems likely to continue. A KPMG Green Power 2011 report, for example, (http://www.kpmg.com/HU/en/IssuesAndInsights/ArticlesPublications/Documents/KPMG-Green-Power-2011.pdf), shows that a majority of surveyed industry insiders expect the use of delayed/contingent payments in M&A transactions in this sector to increase. KPMG’s Andy Cox has been quoted as saying that, “M&A in the renewables sector is [heating] up – but investors are cautious [and] crave policy certainty.” The use of earnouts and other contingent/delayed payment structures can often bridge a value gap to help buyers complete transactions, while mitigating their regulatory, competitive, and other risks.
Most often, earnout structures are based on satisfying certain financial targets for a period of time after the closing of the transaction. In Real Goods Solar, Inc.’s June 2011 acquisition of Alteris Renewables, Inc. (http://www.sec.gov/Archives/edgar/data/1425565/000119312511174608/dex21.htm), for example, additional consideration payable to the sellers was based on Alteris satisfying certain income and cash flow targets for the 2011 fiscal year.
In addition to earnings or other financial targets, which often depend in part on the buyer’s post-closing operation of the business, the parties can also consider other milestones as a basis for the earnout payments. For instance, technical, development, and regulatory milestones might form a more suitable basis for measurement and could include targets for, among other things, (i) development, commercial operation, and/or interconnection, (ii) capacity, (iii) operating standards (e.g., system availability, system degradation), (iv) land acquisition, and (v) financing.
For example, in GDF Suez North America’s June 2011 acquisition of the Knob Hill Wind Farm project from Sea Breeze Power Corp. (http://renewableenergylawyer.blogspot.com/2011/07/sea-breeze-power-corp-closes-12-million.html), additional milestone payments are payable as the project moves through construction and into commercial production. Additionally, Sea Breeze receives an “ongoing royalty based on a percentage of gross revenue generated by the project.”
In the July 2010 acquisition of Crystal Systems, Inc. by GT Solar International, Inc. (http://www.sec.gov/Archives/edgar/data/1394954/000110465910040877/a10-15025_18k.htm), an additional $21 million in cash (or approximately 26 percent of the total potential consideration) was to be paid upon achievement of certain financial and technical targets.
As a variation on the earnout concept, private transactions also could be structured as a staged purchase of equity where achieving certain milestones would trigger additional share purchases. For example, in GE Energy’s March 2011 acquisition of Converteam (http://www.genewscenter.com/content/Detail.aspx?ReleaseID=12186&NewsAreaID=2), GE Energy initially purchased 90 percent of the stock of Converteam for $3.2 billion with the remaining 10 percent retained by Converteam’s senior management. GE Energy entered into separate agreements with management pursuant to which GE Energy would purchase the remaining 10 percent from senior management over the next two to five years. The purchase price for management’s shares is variable based on the “time of sale, business performance and other factors.”
While the Converteam structure appears designed to provide management with performance and retention incentives, a similar structure could be used to address regulatory or competitive uncertainty. In such a structure, a buyer might start by purchasing less than 100 percent of the target’s equity, with an agreement to purchase the remaining equity at prices that depend upon the target achieving certain development or performance milestones.
For so long as regulatory and competitive risks remain volatile, transactions involving renewable/greentech energy can benefit from a wide variety of earnout transaction structures. These structures, when developed creatively based on the industry and specific target company, can be a powerful tool to facilitate transactions in an uncertain environment.
The views expressed in this article are those of the writers.