Briefing

Back to the future: forward selling future income

Posted by : Martin Blake | Date posted : 23/07/2014

The ability of sporting organisations to raise debt finance in the last few years has been mixed - those already wealthy or with tangible collateral such as land have generally been able to raise funds when needed, albeit lenders have been more acutely aware of reputational issues when things go wrong. Those sporting organisations not so fortunate have struggled to find traditional lenders willing to extend financing facilities to them. 

In light of this changing landscape, Martin Blake explains what forward selling future revenue streams is, the considerations and documents involved in using it and considers what sort of future this type of financing arrangement has, not just for football clubs, but sporting organisations generally.

Football clubs have been in the vanguard of finding funding solutions. As traditional banks have drawn back from all but the biggest of clubs both for reputational and risk reasons, other types of lenders have entered the market and, rather than the provision of general debt facilities, forward selling specific future revenue streams (such as broadcasting income (see footnotes 1 and 2 for examples of this), sponsorship revenue and amounts owing under player transfer agreements) has become popular. Whilst this has provided an effective way of raising short term cash and can be used to effectively manage the cashflows of a club across the season, it has attracted some negative publicity - for example, Vibrac Corporation, a BVI based company and one of the leading providers of this type of financing, has been described in the press as a "payday lender" for football clubs[1]. Only recently their involvement in the proposed sale of Reading FC came under further press scrutiny[2] – Vibrac were a secured lender to the club (which had apparently borrowed from them against the parachute payments payable to them by the Premier League) and so were able to have a large say in the sales process.

The various English and European football governing bodies have also introduced rules to regulate lending against future revenue streams:

  • The Football League restricts any club which has assigned (as security for a loan) its entitlement to distributions from the 'Pool Account' from registering a player while the financing remains in place[3].
  • The Premier League Rules incorporate certain disclosure and consent requirements if a club wishes to grant security over its entitlement to 'Central Funds' (as security for a loan)[4].
  • The implementation of UEFA's Financial Fair Play Regulations with their aim to ensure clubs 'live within their means' by complying with a break-even requirement, may also have a bearing on clubs' ability and willingness to take on this type of financing.

In light of this changing landscape, Martin Blake explains what forward selling future revenue streams is, the considerations and documents involved in using it and considers what sort of future this type of financing arrangement has, not just for football clubs, but sporting organisations generally.

Funding against future revenue streams – what is it?

Sporting organisations (i.e. clubs, governing bodies or other entities which own or run a sporting event or team) generate a range of revenue streams or receivables, such as sponsorship and merchandise income, broadcast revenue and transfer fees which are paid in instalments. These income streams are often fixed in terms of amount and payment dates. They are almost certain to be paid given the financial strength of the payer. 

Forward funding or monetising future revenue streams involves a lender loaning an amount of money (which is based on the total value of the particular revenue stream, discounted to provide an element of profit for the lender – which typically equates to the interest and fees which would have been charged over the period in question) to the sporting organisation due to receive the payments (the "borrower"). The principal security for the loan is the assignment (by way of security) of that revenue stream to the lender.

An alternative structure would be for the 'lender' to purchase (at a discount) the underlying revenue stream (this is commonly known as forward selling). One example of this is the endorsing (or assigning) of promissory notes which are sometimes issued by football clubs as a way of paying player transfer fees in instalments.

With either method, the funding can be provided on either a:

  • 'recourse' basis - so if the revenue stream falls away or proves to be insufficient to cover the amount of funds provided, the lender will still have a claim against the borrower; or
  • 'without recourse' basis - so the lender looks to the revenue stream alone as the source of repayment. 

By necessity, the duration of this type of financing arrangement does not extend beyond the term of the revenue stream in question and so is typically provided over a relatively short timeframe with anywhere from 6 months to 3 years being common.

 

There are advantages for both borrower and lender of this type of arrangement:

  • the sporting organisation benefits by having immediate funds and, if the financing arrangement is structured without recourse, it will take away the uncertainty of future revenues coming through at all.
  • as margins for lending against real property are subject to downward pressure in a buoyant property market with more lenders returning to property lending, this type of financing provides lenders with a greater return on a relatively short-term basis and, if sensibly structured with appropriate financial and legal due diligence carried out, in a secure way.

How strong is the underlying revenue stream and is it fundable?

A detailed analysis of the contract governing the revenue stream and a consideration of the creditworthiness of the borrower and counterparty are crucial to any decision to lend against future revenue streams. Factors to be considered include:

  1. At a commercial level, both parties will be aware of the positive immediate impact on the borrower's cash-flows but will also want to be satisfied that the borrower is not disposing of future cash-flows which are needed to fund its ordinary running costs in order to meet current shortfalls. For football clubs, this point is topical as financial fair play regulations start to bite but really it is something any prudent lender would assess as part of its credit analysis of a proposed lending transaction and monitor on an on-going basis throughout the term.
  2. Contract governing revenue stream must be assignable – without this, the financing arrangement will not work as described.
  3. Events which may stop or reduce revenue stream – it is imperative that the agreement governing the revenue stream must not terminate on the insolvency of the borrower (unless the lender is comfortable that this is extremely unlikely). Beyond that, it is important for the lender to understand in what circumstances the counterparty to the underlying contract is able to terminate or otherwise withhold payment. This may be much less relevant in respect of a contract where the borrower performs all of its obligations upfront (e.g. by selling a player) but, for contracts which require an element of performance from the borrower, the lender must also be comfortable that they will perform and will want to monitor this.
  4. For sponsorship agreements or other arrangements where the name of the counterparty is associated with the borrower, the counterparty may also reserve the ability to terminate or withhold payment if a club or its players do something which impacts on the reputation of the sponsor (the last few months have provided plenty of potential examples: Nicolas Anelka and Luis Suarez to name but two).
  5. Impact of football creditor rule – this is something which requires careful analysis by lenders to English football clubs.
  • The payment of central revenue such as broadcasting or league sponsorship funds is subject to the football creditor rule which allows the relevant football league (either the Football League or the Premier League) to divert such funds to satisfy the debts of a club suspended from the league (by reason of its insolvency or otherwise) which are owed to football creditors (principally other clubs, players owed wages and any league body). To the extent permitted by the relevant football league, any lender dependent on such revenue streams to repay its loan will want to be very sure that there is no possibility of the borrowing club being suspended (i.e. they will only deal with the financially strongest clubs).
  • Other revenues owed to clubs such as transfer fees, whilst they may be paid through a central account with the Premier League or Football Association, are not subject to the football creditor rule. In fact, when lending to a football club secured against transfer fees owing from another football club, the football creditor rule can actually benefit the lender by reducing the counterparty risk involved with the payments owing to the selling club under the transfer agreement potentially coming, if needs be, from central revenues otherwise payable to the buying club.

A guide to the documentation involved

Facility letter - or other document setting out the terms and conditions of the financing or purchase. This will include provisions covering:

  • pricing;
  • whether there is recourse back to the sporting organisation - either it is structured as a loan which is required to be repaid regardless of whether the revenue stream materialises or, for a purchase, the documentation may include an indemnity to similar effect;
  • representations and warranties which are typical in a financing arrangement (and may include specific confirmations as to the contract or contracts being financed);
  • monitoring rights of the lender – both in respect of the borrowing club's finances generally and, if relevant, in relation to their ability to perform under the underlying contract;
  • undertakings which will set out what the sporting organisation may or may not do – for example, it may (but will not necessarily) include a restriction on granting security over its assets and/or restrictions or limits on incurring further borrowings or making acquisitions and disposals, as the lender seeks to keep the borrower in the same (or better) financial position as at the outset; and
    • events of default, such as non-payment, insolvency or breach of the terms of the facility letter – which, if included, will give the lender the right to ask for their money back immediately rather than at the end of the agreed term.

Assignment of underlying contract – whether by way of security (for a loan) or absolutely (for a purchase). With the former, the lender may only step into the shoes of the borrower in the event of a default by the borrower. In the case of the latter, the parties to the underlying contract effectively switch, allowing the lender to deal directly with the counterparty immediately.

Notification to counterparty of underlying contract – this is important to perfect the assignment (in accordance with s136 of the Law of Property Act 1925[1] which applies even though no real property is involved). Any notification will also give clear instructions to the counterparty as to where payments should be directed in practice.

Other sweeping security – where there is recourse back to the borrower, the lender may take a debenture over all of the assets of the club to secure this liability.

The future?

Call it what you will – forward funding, forward selling or monetising future revenue streams – this method of debt financing has been, for many years and in one way or another, a common type of financing arrangement used by many businesses across a range of sectors.

For any sporting organisation which generates the right sort of revenue streams, forward funding provides a way of meeting its short term liquidity needs and, for lenders, it delivers an alternative and, if structured and documented correctly, secure way of lending money to such organisations.  It has received a certain element of bad publicity recently with football clubs but it certainly does not, of itself, suggest that an organisation which employs this as a way of managing its cash flows is living outside its means. Far from it – it remains, in essence and if used prudently, a flexible and practical financing tool which should always merit consideration by lenders and sporting organisations where the circumstances permit.

 

Martin Blake is a partner in the Banking team and a member of the Sports Group. He advises lenders as well as clubs, governing bodies and other organisations within the sports sector on structuring and documenting a range of financing transactions.

If you require further information on anything covered in this briefing please contact Martin Blake (martin.blake@farrer.co.uk; 020 3375 7353) or your usual contact at the firm on 020 3375 7000. Further information can also be found on the Sports page on our website.

This publication is a general summary of the law.  It should not replace legal advice tailored to your specific circumstances.

© Farrer & Co LLP, July 2014