Involvement of the Franchisor in Debt Funding

In the previous article, we have already seen that it is common for sporting franchises to raise significant amounts of debt funding. We also know that there are certain special characteristics of sports franchises that need to be taken into account before giving out loans to them.

One more such important characteristic of debt funding to sports franchises is the involvement of the franchisor in such deals. Generally, a loan agreement between any organization and a bank is a bilateral agreement. This means that the deal must be signed by both parties in order to be valid. However, this is not the case with sporting franchises.

The franchise agreements are often structured in such a way that the franchisors also have significant control over how the franchises manage their finances. Hence, this creates a unique situation wherein the banks have to be careful that any agreement being made between the bank and the franchise is also carefully vetted by the franchisor in order to make sure that it is valid as per their rules. Hence, the debt agreement between a bank and a sports franchise almost becomes a tri-party agreement.

In this article, we will have a closer look at the involvement of the franchisor at various stages of the debt funding process.

1. Day to Day-to-Day Functioning: There are many sporting franchises across the world that limit the amount of debt that their franchises can take on the balance sheet.

   For instance, the NBA as well as the NFL, both of which are based in the United States, limit the amount of debt that their franchises can undertake. This is known as the debt ceiling.

   It is important for banks and other lending institutions to ensure that the sporting franchise remains compliant with these rules even after receiving the debt

2. Resale of Loans: Sporting leagues want to ensure that they are in control regarding who their franchises owe money to. It is for this reason that sporting franchises have rules in place that limit the ability of the banks to resell their loans. If any loans have to be securitized and sold to parties other than those who originated the loans, the franchisor also needs to be notified.

   Generally, if it is purely a financial transaction i.e. one bank assigning a loan to the other, the sporting league does not object and allows the transfer to take place. However, if it is an attempt to gain control over certain assets of the league, then the franchisor may reject such a transfer.

   The main intention behind keeping this control is to ensure that “vulture funds” are not able to obtain ownership of the debt owed by the franchises. This will allow vulture funds to take control of the franchise operations which might be detrimental to the interests of the franchisor as well as other franchises in the league.

3. Debt Default: We already know that banks take the assets of sporting franchises as collateral while giving out loans to them. Hence, ideally, if the franchise is not able to pay back the loan, then the lender should have the right to take possession of the collateralized asset and sell the same in order to recover their losses. However, many times, this may not be the case when it comes to sporting franchises. This is because the franchise is not really an independent company.

   The franchise derives its economic value because it is a part of the overall ecosystem that the franchisor has built. It is for this reason that franchisors also want to exert some control over the situation if a franchise is unable to pay down the debt.

   Unlike normal circumstances, the banks may not get complete control of the assets. This means that they may not be able to sell the franchise assets to the highest bidder in order to recover their dues.

   It is common for the sporting league to have the first right to dispose of the assets of the franchise in the event of a default. This means that if a team has defaulted on its debt, the franchisor will be given the option to find a suitable buyer for the league so that the debt owed to the third party can be paid off. Only if the league is unable to find a buyer, will the bank be able to take control of the assets and liquidate them on the open market.

The bottom line is that the franchisors realize that the economic value of any franchise is connected with others and the entire league as a whole. Hence, if they do not control the debt funding these franchises receive, they ultimately end up leaving the backdoor open to hostile takeovers. Hence, they create elaborate rules in order to prevent such loss of control.

However, the extent to which this control can be legally exercised by the franchisor is debatable. This is because some of the rules and regulations created by these franchisors are actually in violation of the bankruptcy code.