A Revolution Coming In Renewable Energy Finance: The Emergence Of Energy Private Equity Funds

Author:Mr John McDonald, Justin Boose, Adam C. Kobos and Vaughn H. Morrison
Profession:Troutman Sanders LLP
 
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Introduction

The emerging trend of energy private equity ("EPE") funds is revolutionizing the renewable energy field, as renewable energy joins leveraged buyouts, venture capital and hedge funds as asset classes that institutional investors and high net worth investors are using to deploy their capital in a diversified manner, with the added "social good" of investing in a sustainable energy future. Sophisticated energy sponsors are increasingly eschewing the traditional project finance structure, in which capital stacks are created for each deal, in favor of a private equity fund structure in which committed capital is deployed by the sponsor in accordance with a specified investment strategy.  From the sponsors' perspective, the goal is the "holy grail" of all private equity sponsors - permanent capital.  This trend can be seen as further evidence of renewable energy maturing as an asset class within the larger investment world.  Since this trend is so new, the terms of EPE funds vary tremendously.  However, some common terms are summarized below.

Committed Capital 

EPE funds typically employ a traditional private equity fund structure in which LP investors sign subscription agreements requiring them to make capital contributions in response to capital calls issued from time to time by the sponsor to fund investments made by the fund in accordance with an agreed-upon investment strategy.  This contrasts with the traditional project finance structure in which the sponsor creates a project company for each investment and then sources investors to provide equity capital for that investment (which is analogous to the "fundless sponsor" model used by some emerging private equity sponsors).  U.S. renewable energy "tax equity" investments are predominantly done utilizing the traditional project finance structure, rather than a committed capital structure.

Investment Strategy 

EPE funds are typically focused on investments in a particular sector  - renewable energy, waste-to-value, etc. - and consent of a majority-in-interest of the LP investors (or, less frequently, limited partner advisory committee ("LPAC")) is required for the EPE fund to make investments that deviate from that investment strategy.

Carried Interest and Management Fees

Carried interest and management fees in EPE funds vary significantly based upon relative negotiating strength of the parties, which is often a function of the sponsor's track record and the sophistication of the...

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