Debt Funding in Sports Franchises

Sporting franchises are also business organizations that operate just like other business entities. Therefore, just like other business entities sports franchises also require debt in order to fund their business.

There have been various institutions such as banks and private equity firms that can provide these required loans to sporting franchises.

Prima facie, it may appear as if these loans are similar to any other business loans. However, that is generally not the case.

Debt funding which is provided to sporting franchises is significantly different from other business loans since it has some peculiar characteristics.

This article provides details about these peculiarities and explains how debt funding to sports franchises is different.

1. Syndicated loan plus revolving credit: The first point of distinction differentiates sports franchises from small and medium businesses. It is important to note that sports franchises are generally funded by individuals.

   Rules created by sporting leagues prevent listing these businesses on the stock exchange. Hence, they have limitations when it comes to raising equity capital. Hence, it is common for sports franchises to raise a significant amount of money via debt. Since the loan amount is significantly high, it is not possible for a single bank to take on such a huge risk on its books.

   It is therefore common for a group of banks to form a syndicate and then lend to the franchise. However, this large amount may only be required for paying the initial purchase price of the franchise. Later on, the expenses can be managed with the help of revolving credit. Obtaining a combination of syndicated credit as well as revolving credit is not common among small and medium businesses. However, it cannot really be said to be a unique characteristic.

2. Collateralization: Banks lend money to any business based on the value of the collateral provided by the business. It is common for banks to lend against the cash flows of the business.

   Banks generally use financial statements of the past to predict future cash flows and then give loans accordingly. However, in the early years of its operations, sporting franchises had negligible cash flows. Hence, banks cannot lend against such cash flows. Therefore, it is common for the banks to use the intangible assets of the sporting franchise as collateral and then make loans against them.

   Also, since the cash flows provided by the day-to-day operations of the franchise are low, it is common for banks are franchises to structure these loans to make bullet repayments. This means that the loans are structured in such a way that only the interest has to be paid back during the life of the loan. The principal amount generally becomes payable towards to end of the loan tenure i.e. on maturity.

3. Complications in Collateral–Corporate Structure: Banks sometimes experience difficulty in taking franchise assets as collateral for loans. This is because the corporate structure of a sporting franchise can be extremely complicated.

   Most people assume that a sporting franchise is just one business entity. However, this is generally not the case. It is common for a sporting franchise to operate a web of subsidiary companies that can span different nations and regulatory regimes.

   Hence, banks have to be very careful while providing funding. They need to ensure that the legal entity pledging the assets has the legal right to do so. Also, they need to ensure that they are in a position to legally enforce their rights to liquidate the asset in case the franchise is not able to pay back the loan.

4. Pre-Funded Interest and Contingency Funds: Sporting franchises tend to have very unpredictable cash flows. Their cash flows can change in the middle of a season because of poor performance of the team or even strikes or lockouts.

   On the other hand, banks want to be sure that their payments are made on time. If the bank does not receive its payments for a period of three months, then they generally declare the loan as a non-performing asset.

   Hence, in order to ensure that the loan is not declared as a non-performing asset and recovery proceedings are not started, many banks insist that a certain percentage of the loan be kept in a different account. This account is called a pre-funded interest account. This is because it is meant to hold interest payments for the next few months which have to be paid to the bank. This account acts as a cushion and gives the bank an early warning when the sporting franchise begins to face cash flow issues.

   There are certain types of banks and financial institutions that also mandate that sporting franchises have to set aside a certain sum of money in order to meet contingency expenses. This money is generally kept aside to ensure that cash flow is not negatively impacted if the franchise faces unforeseen scenarios such as strikes and player lockouts.

The fact of the matter is that it is common for sporting franchises to deal with banks and other lending institutions in order to take on debt for running their business.

However, there are certain unique terms and conditions which are imposed by banks on sporting franchises which are not imposed on other businesses. This is what makes obtaining debt funding a somewhat unique and challenging process.