Legal Insights for Data Center Developers: Structuring Investments

In the rapidly evolving landscape of digital infrastructure, data center developers face unique challenges and opportunities. This blog post delves into the intricacies of structuring investments and working with investors in the data center sector.  

In this discussion, Womble Partner Tara Gorman engages with Womble Partner Tracy Bacigalupo to explore the legal considerations that data center developers must navigate in the context of a capital raise or sale of ownership interests. Their conversation covers investment structures, regulatory compliance, and investor relations, providing valuable insights for those involved in data center development.

Tara Gorman: What are the primary legal considerations for data center developers when structuring investments?
Tracy Bacigalupo: Data center developers must carefully consider the structure of their investments to balance risk and return. Common structures include joint ventures, special purpose vehicles (SPVs), and direct equity investments. Joint ventures bring together the expertise and capital of multiple parties, while SPVs isolate risks by housing the data center project in a separate legal entity. Direct equity investments involve acquiring equity stakes directly in the operating entity, granting significant control and financial returns. Each structure is tailored to the project's objectives and investors' needs, while considering tax implications and liability exposure. Additionally, the choice of structure can impact the project's ability to attract financing, as certain investors may prefer specific structures over others. For instance, institutional investors might favor SPVs for their risk isolation benefits, while strategic investors might prefer joint ventures for the collaborative opportunities they present .

Tara Gorman: How can data center developers manage investor relations effectively?
Tracy Bacigalupo: Maintaining strong investor relations is critical for long-term success of the data center developer. Regular and transparent communication builds trust with investors. This includes financial reporting, operational updates, and compliance reports. Adhering to confidentiality agreements is also essential, especially in competitive markets where data center information is sensitive. Effective investor relations by data center developers also involve proactive engagement with investors, addressing their concerns and providing timely updates on project milestones. This can include quarterly earnings calls, investor newsletters, and dedicated investor portals that provide real-time access to project information. By fostering a culture of transparency and accountability, data center developers can build lasting relationships with their investors .

Tara Gorman: What are the key legal elements in investment agreements for data center projects?
Tracy Bacigalupo: The data center investment agreement outlines the rights and responsibilities of all parties involved. Key legal elements include control provisions, exit strategies, and profit-sharing agreements. Control provisions determine who has decision-making authority, while exit strategies outline how investors can exit their investments. Agreement valuation mechanisms specify how revenues are distributed, especially in large-scale data center projects with multiple stakeholders. These agreements also often include provisions for dispute resolution, such as arbitration or mediation, to address any conflicts that may arise between investors and project managers. Additionally, investment agreements for data centers may contain covenants that restrict certain actions by the project's management, such as incurring additional debt or making significant capital expenditures without investor approval .

Tara Gorman: What risks do private equity firms face when investing in data center projects?
Tracy Bacigalupo: Private equity firms face several risks when investing in data center developments, including project delays, technological risks, market risks, and regulatory or economic changes. These risks can impact the value and profitability of data center projects. Mitigating these risks involves drafting provisions for contingencies, indemnification, and warranties in the investment documents. For example, indemnification provisions can protect investors from losses arising from breaches of representations and warranties by the project's management. Additionally, private equity firms often conduct extensive due diligence to identify potential risks and develop strategies to mitigate them. This can include conducting market studies, assessing the project's technological infrastructure, and evaluating the regulatory environment .

Tara Gorman: How important is compliance with regulatory requirements for data center developers?
Tracy Bacigalupo: Compliance is a critical pillar of any data center equity financing project. Data centers handle vast amounts of data and face multiple layers of regulation. Compliance with securities laws, data privacy laws, and environmental standards is essential. Addressing these compliance areas early can help data center projects avoid costly delays and reputational damage. For instance, compliance with data privacy laws such as the General Data Protection Regulation (“GDPR”) and  the California Consumer Privacy Act (“CCPA”) is crucial for data centers that handle personal data. Additionally, compliance with environmental regulations, such as those governing energy efficiency and carbon emissions, is essential for obtaining permits and maintaining public trust. By proactively addressing regulatory requirements, data center developers can minimize the risk of legal and financial penalties .

Tara Gorman: What role do governance structures play in data center projects?
Tracy Bacigalupo: Governance structures set forth in partnership or shareholder agreements clearly delineate roles, decision-making processes, and voting rights involved in a data center project. These structures ensure that the interests of all stakeholders are aligned and that conflicts are resolved efficiently. Mechanisms like mediation or arbitration can be included to address disputes between investors and project managers. Additionally, governance structures often include provisions for the appointment of board members or advisory committees to oversee the project's management and provide strategic guidance. By establishing clear governance structures, data center developers can ensure that decision-making processes are transparent and that all stakeholders have a voice in the project's direction .

Tara Gorman: How can data center developers ensure the financial viability of their projects?
Tracy Bacigalupo: Ensuring financial viability involves conducting thorough due diligence at the outset. This includes investigating the financial viability, scalability, and market potential of the data center. Investors often secure guarantees with respect to performance metrics or covenants restricting certain management actions to protect their interests. Additionally, data center developers can enhance financial viability by securing long-term contracts with customers, such as cloud service providers or large enterprises, to ensure a stable revenue stream. By conducting comprehensive financial analysis and securing commitments from key stakeholders, data center developers can mitigate financial risks and ensure the project's long-term success .

Tara Gorman: What are the environmental considerations for data center developers?
Tracy Bacigalupo: Data centers consume substantial energy and can have a significant environmental impact. Compliance with energy-efficient standards, green building standards, and renewable energy mandates is crucial. Demonstrating efforts to offset or minimize environmental impacts is essential for obtaining permits and maintaining public trust. For example, data center developers can implement energy-efficient technologies, such as advanced cooling systems and renewable energy sources, to reduce their environmental footprint. Additionally, developers can engage with local communities and stakeholders to address environmental concerns and demonstrate their commitment to sustainability. By prioritizing environmental considerations, data center developers can enhance their reputation and secure the necessary approvals for their projects .

Tara Gorman: In conclusion, the legal landscape for data center developers is complex and multifaceted. By carefully structuring investments, managing investor relations, and ensuring compliance with regulatory requirements, data center developers can navigate these challenges effectively. The insights shared by Womble Partner Tracy Bacigalupo provide a comprehensive understanding of the legal considerations involved in data center projects. With meticulous planning and execution, data center developers can achieve successful outcomes and drive innovation in the digital infrastructure sector.

About Womble Partner Tracy Bacigalupo. Tracy serves as the Managing Partner of our New York office and co-head of our M&A/Business Transactions Practice Group. Tracy focuses her practice on corporate, M&A, and corporate governance matters. She represents public and private acquirers, target companies, and special committees in M&A transactions, including mergers, divestitures, and other collaborations involving strategic investors and private equity and venture capital firms. She has substantial experience with technology transactions and intellectual property development and protection. In February 2023, Tracy was named to Global M&A Network’s list of “Top 50: Americas - M&A Lawyers”, a distinction that recognizes her leadership and record of closing value-creating transactions. She was one of only three women on that year’s list. She also has been identified by the legal ranking and news service Lawdragon as one of its “3000 Leading Lawyers in America” and “500 New Stars, New Worlds,” and by The Legal 500 USA for her work in the areas of mergers and acquisitions and project finance. Tracy regularly counsels Maryland-formed real estate investment trusts, open- and closed-end investment companies, and their directors and trustees on a broad range of matters, including strategic transactions, capital markets transactions, financings, and corporate governance issues.

About Womble Partner Tara Gorman. Tara is a Co-Leader of the WBD Data Center Team. Tara maintains a diverse real estate practice, concentrating on commercial real estate acquisitions and sales; office, retail, and data center leasing; and telecommunication license agreements. She has represented a range of institutional investors in connection with their real estate investments, as well as governmental and quasi-governmental agencies with respect to their real estate holdings.