Increasing feature of the energy transaction landscape
Following the agreement at COP28 to “transition away from fossil fuel energy systems,” and to accelerate investment in low- and zero-carbon emission technologies, strategic minority investments are set to become an increasing feature of the energy transaction landscape. Investor focus is being directed toward new energies and clean tech, including interconnectors, battery storage, smart grids, EVs, synchronous condensers, biogas, bio and synthetic fuels, floating wind, carbon capture and storage, green hydrogen, hydro and tidal stream, to name but a few.
With the drive to achieve net-zero emissions by 2050, the International Energy Agency (IEA) consider that global annual clean energy investment will need to increase to c.US$4 trillion by 2030, and a key means to achieve that will be by way of strategic minority investments.
Whilst “venturing” is nothing new, it clearly makes sense: exciting, early-stage ventures looking to scale-up and build credibility have found that partnering with well-established, highly capitalized energy companies navigating an increasingly crowded market, and searching for “the next big thing,” can be an effective route-to-market. Conversely, capital-intensive, long-term, nascent energy or clean tech projects are inherently risky, so there is a clear need for investors to spread risk and avoid overexposure to a single investment.
Energy venturing peculiarities
There is increasing appetite for energy venturing from the energy majors, other integrated energy companies, infrastructure funds and private equity funds, and investment opportunities are in no short supply.
For a number of investors, particularly the energy majors, such investments also present “value add,” or other revenue-generating opportunities which would not otherwise be available. This, together with the long-term investment horizon, means that the relationship between investor and target is generally much more holistic and strategic. It also means that the negotiating dynamic and investor protection considerations require an approach which is particular to energy venturing.
Key considerations
In that context, the following topics are just some of the key issues to consider when implementing a strategic minority investment:
- Due diligence – due diligence is clearly an important workstream on any M&A transaction; however, in a venturing context, there is typically limited time, resource and appetite (on all sides of the deal) to undertake a broad and lengthy due diligence exercise. Therefore, to maximize efficiency and the utility of the exercise, investors should identify the key value-drivers for the transaction at an early stage and focus their efforts on reviewing those specific areas. Whilst the diligence scope will need to be appropriate (particularly if considering warranty and indemnity insurance – see below), the most successful – and transactable – investors are those that can clearly identify the key areas of focus, diligence those areas quickly and take a view as to the nature and materiality of any risks. Also, early-stage companies rarely have complex contractual arrangements, disputes or liabilities to navigate, so a nimble approach to due diligence is often the most appropriate course of action.
- Warranties and indemnities – the value of the warranty and indemnity package will vary from transaction to transaction depending on factors such as the stage of the venture and the dynamic between investor, target and the broader shareholder base. In that context, it will be important for a strategic minority investor to be realistic regarding the value of such protections, and to scope them accordingly. In some circumstances, a target will be unwilling to provide warranties or indemnities (other than fundamental warranties as to capacity or title) and warranty and indemnity insurance could be a useful tool to bridge such a gap. Where warranty and indemnity insurance is used, the scope of due diligence will need to be sufficiently broad so as to maximize coverage; therefore, investors should consider this option at the outset of the deal.
- Negative control – by its nature, a minority investment means that the investor cannot control the decision-making of the venture; however, there will be a number of fundamental aspects of the venture over which an investor will want to have negative control. The breadth of such negative control will depend on the value of the investment being made and the make-up of the shareholder base, but – typically – matters such as changes to the business plan, annual budget or capital commitments, share capital reorganizations, amendments to the articles, changes to key employee incentivization, raising external indebtedness and disposing or acquiring material assets, will require the consent of a minority investor holding a material proportion of the issued share capital.
- Board representation, observers and information rights – a strategic minority investor will usually want to secure one or two board seats, or – at the very least – a right to appoint observers to the board of the venture entity and any sub-committees. Such representation rights are also typically supplemented with enhanced information rights designed to allow the investor to keep abreast of all relevant developments in relation to the venture.
- Dilution protection and transfers – protections surrounding dilution and transfers are fundamental areas of focus for strategic minority investors. There is little value in securing negative control or representation rights if the investor can be diluted subsequently and lose such rights (at least without being offered a preferred right to participate in any dilutive fundraising on a pro rata basis). Equally with transfers, the investor will want to ensure that any keystone investor or management shareholders are “locked-in” for an appropriate period to maximize the venture’s chance of success, and that any proposed transfer of shares is subject to a preferred right to acquire such transfer shares on a pro rata basis. Depending on the strength of the investor’s negotiating position, it may also wish to impose restrictions on transfers to any undesirable prospective third-party investors.
- Related party matters – as mentioned previously and particularly in the energy sector, a key driving factor for making a strategic minority investment will be the opportunity to provide “value-added” services to the venture. Naturally, this will give rise to potential conflicts of interest as between the investor’s role as shareholder (including, if relevant, such shareholder’s appointed directors) and as contractual counterparty. This applies just as much to the incoming investor as to the existing investors, and so a fair balance will need to be struck to ensure that a conflicted shareholder/director is excluded from any relevant decisions with respect to a related party matter.
Andrew Davies (Partner) and Sam Morrey (Senior Associate) are corporate energy lawyers with Norton Rose Fulbright LLP based in London and recently advised TotalEnergies on its strategic minority investment in the Xlinks Morocco-UK Power Project.
