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Lending to Football Clubs
Financing a football club comes with its set of risks including bankruptcy. Mark Bladon analyses a club’s sources of income, its main overheads, traditional sources of financing and establishes why creativity is required to protect a bank’s downside risk.
After a glorious summer of sport the football season has begun in earnest once again. Often it can be as interesting to look at what happens off the pitch, as well as on it.
The big news from a financial perspective was the IPO of Manchester United, which finally got away after a number of false starts. There were doubts about the ability of the company to pay back its debt and fervent protests from fans surrounding the Glazer’s financial triumph as a result of the sale of an equity stake. However the shares opened at $14, lower than the anticipated $18 per share valuation. The Glazers made their money but one wonders about future financing for clubs especially given their high debt levels.
Only a few months ago Tottenham declared its intention to de-list its shares from AIM stating that the public quote restricted the club’s ability to raise finances. It also suggested that the expensive administrative burden associated did not improve liquidity in the shares at all.
One has to ask the question – does a public listing offer a solution to the financial troubles faced by many football clubs? Are there alternative ways of attracting funding for a club? Are banks attracted by the proposition of lending to a Premier League club?
The Important Numbers – Transfer fees and broadcasting income
A club’s income is generally generated from three main sources – Match day income, player transfer fees and TV broadcasting rights (particularly for Premier League clubs).
This year around £600 million was spent by Premier and Football League clubs on buying and selling new talent. Equally, with 185,000 hours of coverage broadcast to 4.7 billion fans across the world, TV rights form a significant portion of a club’s revenue. The trick is in balancing the two to preserve a financially solvent company.
Now that the transfer window has closed, and the Club Finance Directors know their commitments, they have to start thinking about how they can fund these large transfer payments and hefty salaries in the short term.
A common solution used to be traditional ‘bank loans’ or ‘overdrafts’, provided by the high street banks.
In more recent times, in a tougher economic environment coloured by a change in rules, a more specialist funding of specific player transfers has gained popularity. This is through the discounting of Promissory notes secured against transfer fees.
A Promissory note is an old fashioned, financial instrument with an unconditional promise in writing to pay a fixed sum of money at a future time. Promissory notes are governed by the Bills of Exchange Act and have very strong enforcement rights. One may think that this outdated form of lending, typically used by merchants in the early 1900s is irrelevant in today’s context but surprisingly, for a football club, it is an oft used form of borrowing.
So why would a bank opt for the promissory note rather than a straight forward line of credit?
The key lies in understanding exactly what happens to the clubs cash flows in the event it were to become insolvent. Banks generally prefer to offer highly secured debt but given the latest ruling from the High Court, it is clear that what at first seems like a strong security package (esp. over broadcasting monies) can be vulnerable to challenge.
The High Court Intervenes
On 25 May 2012, an important decision was made in the High Court which received surprisingly little coverage given its relevance to our national game. Justice Richards upheld the “Football League and Premier League’s” right to prioritise payments to football players and to settle unpaid football transfer payments (the ‘football creditors’ rule) at the expense of other creditors, in this case, HMRC.
Under the current rules, the Premier and Football Leagues have the right to settle player transfer fees directly, from broadcasting monies, instead of paying it first to a football club facing administration as a result of outstanding debts to organizations like the HMRC.
The Football League argued, successfully, that by removing this rule there was a risk that football clubs expecting monies from other clubs, in relation to player transfers, would refuse to play each other and that a default by an insolvent club could lead to ‘contagion’ whereby one missed payment could lead to another club’s administration, and so on, resulting in a domino effect of insolvencies.
The challenge to this rule was brought against the Football League by HMRC in relation to tax payments owed to the government by Portsmouth FC – the first club in the Premier League’s 20-year history to file for bankruptcy.
No doubt the Football League are delighted they successfully defended this idiosyncratic and quite unique treatment, but have they thought through what the consequences are for creditors other than HMRC, and the impact this has on football clubs?
I am, of course, referring to traditional bank debt. Clubs in the Premier and Football Leagues have a material amount of bank debt and banks, (given their own problems and increasing regulatory and capital burdens) are in retreat from this sector.
Why traditional debt is an unattractive lending option
A security package for bank debt would normally include a floating charge over any cash inflows to the club, including an assignment over the TV broadcasting revenues paid by the Premier League. This is because TV broadcasting revenues are almost always the single largest revenue item that a club receives, capable of accounting for up to half a club’s total revenue. These receipts (roughly £40m with lump sums payable in August and January) are often the principal source of repayment for bank loans taken out by clubs, in order to finance transfer activity in the July/August and January transfer windows.
However, under current rules, the Premier League can simply redirect these monies away from an insolvent club and pay football creditors directly.
It becomes highly unfavourable for a bank like Investec to provide debt to a club when it’s main revenue stream, and the bank’s main source of security, can disappear at the first sign of trouble.
Therefore in the absence of further shareholder support, a club collapses unless a white knight can be found to inject equity in to the club – a far more challenging process than raising bank debt.
At Investec we are often asked to provide debt direct into clubs, secured against TV monies, but we find it difficult to accommodate all but the strongest of football clubs, for the reasons noted above. This is why we specialise in player transfer finance via the discounting of Promissory notes, where we align our interests with the club, and more crucially with the football creditors rule.
A bank’s view on the situation
I think the Football League and Premier League missed an opportunity here to make their clubs deal with the realities of the real world, in the same way that other businesses have to.
As things stand, clubs can run their businesses into the ground chasing promotion, European football or trying to avoid relegation by spending way above their means, and if a club defaults on a transfer payment the other clubs know that they will still be paid by the Premier league.
If the football creditor’s rule were removed, perhaps clubs would have to take more of a collective responsibility for the way their fellow members operate. It would only take one non-payment for a club to be ostracised in terms of player trading (a good form of self policing!) and if a club becomes insolvent because of one missed payment, one has to question whether the club deserves to survive.
The Football League have made huge efforts to bring financial stability to their clubs by embracing UEFA’s financial fair play rules and imposing conservative wages/turnover ratios on their clubs. In my opinion it is this which can have a positive impact on clubs’ financial position, rather than the ‘football creditors’ rule, which does not offer any incentives to a club to operate within its means.
One final point to note is that whilst it is key to the bank’s risk management to understand the risk involved when providing specialist lending, it is also in the client’s interest to go with a funder that understands its business and the risks involved. If the bank gets repaid, it isn’t going to call its loan or make the club insolvent. If it suddenly finds itself at risk of non-repayment, it is more likely to take steps to protect itself.
This article is for general guidance only and should not be relied up as constituting advice suitable to your particular circumstances. You should seek your own independent advice from a suitable professional before taking any action following this article.