SPORTS INVESTMENT INSIGHTS
Investing in football: equity vs. debt
In advance of the 2023/24 Season, the Premier League followed in the footsteps of the NFL and became the first football league to introduce controls on leveraged buyouts. This move is consistent with various regulatory changes across European football in recent years, all seeking to control levels of debt and emphasise the importance of equity finance within a football club’s funding structure.
This article:
- Summarises the "Acquisition Leverage Test" introduced by the Premier League; and
- Sets out the importance of equity funding in achieving greater flexibility under football financial regulations (both at UEFA level and at Premier League/English Football League level).
Summary of the Acquisition Leverage Test
The Premier League’s Acquisition Leverage Test is triggered as part of assessing any proposed acquisition of "Control" (i.e. the power to exercise or acquire direct or indirect control over the policies, affairs and/or management of a Premier League club (Club)). Under the test, the ratio of Acquisition Debt to Acquisition Equity in any proposed acquisition of Control cannot exceed 65%. Information on how the acquiror intends to service any Acquisition Debt will also need to be provided to the Premier League.
Ratio of Acquisition Debt to Acquisition Equity in any proposed acquisition of Control, under Premier League Rules
Acquisition Debt for these purposes means all obligations in respect of “Borrowings” (this term is broadly defined to include loans, bonds and all other indebtedness with the commercial effect of borrowing) incurred by: (i) the proposed acquiror to the extent that such obligations are or will be secured over the assets of the Club; and/or (ii) the Club itself, each in connection with or following the acquisition of Control of the Club.
Acquisition Equity means any funds provided by the proposed acquiror in connection with the acquisition of Control that do not amount to Acquisition Debt.
The test will be applied at least three times in connection with an acquisition:
- at a point in time prior to completion of the acquisition, as determined by the Premier League Board (the Board);
- 6 months following that first test; and
- 12 months following the first test.
The Board can also undertake the test at further points at its discretion at any time prior to the date which falls 12 months from the first test.
The test is implemented and enforced in various ways:
The Premier League will not provide approval to the acquisition, and therefore the acquisition will be unable to complete, until the Club and/or the proposed acquiror has complied with its obligations to submit an "Acquisition Leverage Compliance Certificate" (confirming compliance with the ratio requirements).
If the submitted certificate is late or confirms non-compliance with the leverage ratio requirements, the Board has various powers, including the power to require the Club to explain any delay or non-compliance and provide a remedial plan and time-frame for correcting such non-compliance.
Where any delay or non-compliance persists for 14 days, the Board has the power to prohibit the Club from making distributions to members and this lock-up will last for so long as the Club is not in compliance with the test.
Club directors can also be disqualified in the event that they provide false information in respect of the certificate.
Importantly, a failure to supply the certificate, a false declaration or false information within a certificate, and a certificate confirming non-compliance with the leverage ratio, are all deemed breaches of the Premier League Rules and subject to disciplinary action under Section W of the Rules (with potential sanctions including an unlimited fine, a points deduction and suspension from the Premier League).
Commentary on the Acquisition Leverage Test
In February 2023, the government signalled its support for an independent regulator for men’s elite football, when responding to the “Fan-Led Review of Football Governance” carried out by Tracey Crouch MP. In its published White Paper, the government forewarned of increasing controls around leveraged buyouts, stating:
“Analysis of prospective owners’ financial resources would be essential in ensuring that owners would be suitable custodians of the heritage assets of football clubs. To help safeguard the financial sustainability of clubs, the government is considering whether the Regulator should set tougher restrictions around leveraged buyouts, whereby the purchase of a club is (in part or wholly) financed through loans secured against the club itself.”
The changes brought in by the Premier League, together with the amendments to its Owners’ and Directors’ test earlier last year, could be seen as part of a package of more stringent regulations which aim to address certain concerns that have led to the proposed arrival of the independent regulator. Therefore, it is worth noting that the Premier League approach could be supplemented by any future regime brought in by an independent regulator. According to the government, draft legislation for the independent regulator is expected “very soon”.
The most prominent takeover that would have fallen foul of the new Premier League restrictions is the Glazer-led takeover of Manchester United in 2005, which had a leverage ratio of approximately 83% and in the interim is estimated to have generated over £1.5 billion in interest payments, financing costs and dividends. Burnley, another Premier League Club, was also the subject of a leveraged buyout by its current owners, the US investor ALK Capital, in December 2020. Critics of that takeover have noted that the previously debt-free club assumed over £100 million of debt connected to the acquisition.
The Premier League is not the first sports league to grapple with restrictions on borrowing. The NFL restricts anyone purchasing a controlling interest (at least 30% of the franchise) to a maximum of $1.2 billion in debt (subject to certain requirements around how quickly it is serviced) in relation to the acquisition. Given the value of NFL franchises are generally higher than average valuations in English football (with the Washington Commanders being sold last year for $6 billion), the NFL’s rule is significantly more restrictive than the Premier League’s leverage test. The NBA and MLS have a limitation on the level of indebtedness that may be incurred by a team/owner, whilst MLB uses a debt service rule basing the level of allowable debt on a multiple of EBITDA (not a relevant metric for most football clubs…).
Primacy of Equity Financing
The White Paper published by the government notes:
“Whilst debt is not inherently problematic, it can lead to problems where it: (i) Challenges the day-to-day viability of the club. This may occur where the cost of servicing debt as a proportion of income (‘debt service ratio’) is very high, impacting cash flow. (ii) Could damage the value of the club. This is when the size of the debt is a large proportion of the club’s future sale value (‘leverage ratio’)."
The approach of football regulators of late has been to introduce regulations to limit the opportunity for these problems to arise.
At UEFA level, evidence of this approach can be seen in the Net Equity Rule at Article 69 of the UEFA Club Licensing and Financial Sustainability Regulations. This rule (which came into force on 1 June 2023) is part of the move away from solely relying on the long-standing "break-even" test, toward a new landscape aiming to promote financial sustainability across European football. The intention is that non-compliance with this rule would result in refusal of a licence to play in European competitions, however, this consequence only kicks in from the 2025/26 season and, until then, non-compliance results in a penalty at UEFA’s discretion.
The rule should limit the ability of clubs to load their balance sheets with debt in order to acquire new players, by requiring them either to (i) have a positive net equity position or (ii) improve their net equity position by 10% on the previous year (with the net equity calculation being a balance sheet exercise where liabilities are deducted from assets). Certain subordinated loans can count as equity for these purposes, provided they are subordinated to all other loans and are not interest-bearing for the next 12 months.
UEFA also allows for equity contributions to give clubs greater flexibility when dealing with its football earnings rule. UEFA licensees must either have an aggregate football earnings surplus or an aggregate football earnings deficit that is within the acceptable deviation. “Acceptable deviation” is €5 million over a three year reporting period, however, the deficit can exceed this level, up to a maximum of €60 million, if such excess is entirely covered by either contributions in the relevant reporting period or equity at the end of the reporting period. This underlines the focus by UEFA on strengthening the balance sheet of clubs.
In a similar vein, the Premier League and the English Football League already have the well-established concept of “Secure Funding” (which effectively includes any equity contributions by way of payment for shares and any irrevocable commitments to fund from an equity participant (through making future payments for shares)). The existence of Secure Funding allows clubs greater headroom in their calculation of any losses for the Profit and Sustainability Rules. In a three season rolling period, a club can incur up to £15m in losses; however, where Secure Funding is in place in an amount equal to or in excess of the club’s cash losses for the relevant period, a club may incur up to an additional £90m in losses before being deemed to be in breach of the Profit and Sustainability Rules (i.e. £105 million).
Conclusion
To ensure compliance with the increased levels of regulation in this area, and to take advantage of any flexibility offered, it is important that investors give due consideration as to how they structure any potential acquisition and indeed any ongoing financing needs of the club.
Investors considering an acquisition of a Premier League club will need to design the capital structure in a way which complies with the Acquisition Leverage Test – which limits the extent to which any borrowing can be secured against, or taken out by, the club itself, and increases the focus on equity contributions.
Post-acquisition, clubs and investors alike will be looking to ensure they maximise the flexibility within the existing regulations. It would therefore be prudent for investors (and particularly consortium investors) to consider:
- the way in which they would respond in the event that a club needed “Secure Funding” in place to provide additional Profit and Sustainability Rules headroom – there may need to be a capital call mechanism in the investment documentation; and
- any appetite for putting subordinated loans into the financing structure (for increased flexibility in the measurement of Net Equity for the purposes of the UEFA regulations).
As the increased regulatory focus on football finances looks set to continue, this area will only become more important for investors and clubs in the years to come.
Find out more
To find out more about how Northridge can help on investments in football, get in touch with Northridge corporate partners Ian Lynam or Mike Herbert.
