France: The Business of Multimedia - A Legal Viewpoint from France No. 6

Last Updated: 31 October 2000
The last in a series of articles in which we have been focussing on 2 sets of issues which are relevant to the business of multimedia. First, intellectual property rights and rights clearance. Second, structuring and financing new businesses.

STRUCTURING AND FINANCING A NEW BUSINESS

Obtaining bank finance
Financing your business through bank debt will also require management, time, input and expense and may impose certain constraints upon the way in which you operate, through the terms and conditions upon which lenders are prepared to advance funds.

To raise finance you will have to show that your business is "bankable". In all probability this will mean providing a business plan to assist the bank in its credit analysis. This plan should contain both historical information as to the business's past financial performance (if any) and forward projections for, at least, the short to medium term (i.e. 3-5 years). These projections should detail the business's anticipated cashflows (including projected revenue, capital expenditure, interest payable, working capital, funding requirements) and capitalisation. As a part of its credit analysis, a potential lender will subject your business plan to careful review and will consider whether any assumptions made by you are reasonable and to what extent your projections are sensitive to factors beyond your control, such as an increase in interest rates. In addition to analysing your business plan, a potential lender is likely to suggest it carries out a diligence exercise. This may include sessions with your key financial and operating staff and/or a valuation of the business's realisable assets. It could also extend to instructing professional consultants to review and report on certain aspects of your business.

What form should bank finance take?
In deciding to raise external finance, be it equity or debt, it will be necessary to ensure that such finance will meet the requirements of your business. Any facility offered to you could include one or more of the following characteristics, only some of which may be relevant to you.
- uncommitted/committed.
- term or revolving credit.
- overdraft.
An uncommitted facility is typical for borrowers of such credit standing that the question is not whether they can obtain the required finance facility but at what price. Certain facilities such as foreign exchange and money market lines, commercial paper and other capital market instruments will typically be arranged on an uncommitted basis.

For a committed facility, since the lender is required to advance funds (subject to the terms of its commitment) you will usually be required to pay the lender a commitment fee, irrespective of whether the facility is used.

A term facility will have one or more specified repayment dates and is usually relevant when medium term (say 5-7 year) funding is required. The repayment dates of a term loan should fit projected cash flows.

Under a revolving credit facility funds will usually be borrowed for relatively short periods, for example 1, 2, 3 or 6 months. This is more appropriate where the funding requirements of the business vary, for example to provide working capital where there is a seasonal business or where necessary to smooth out a cash flow receipts/payments cycle.

An overdraft facility will give you the maximum flexibility but, whilst its availability may be committed it will usually be repayable on demand.

Security
Bank lenders will often require security over all or part of a borrower's assets and in any event they will ordinarily require a borrower to agree to a negative pledge (i.e. a contractual commitment that it will not create security over any of its assets in favour of other lenders). In order to facilitate a lender's decision as to whether security will be required and as to what assets it should apply it will be necessary to consider the following:
- type of assets owned by the borrower.
- whether there are existing negative pledges (e.g. in leases) and other contractual restrictions preventing the granting of security.
- costs involved - stamp duties and notarial fees payable on the grant of security may be prohibitive in relation to the value of the asset.
- effect on creditors - will other creditors, for example trade suppliers, continue their prior dealings if security is given to lenders.
In addition to any security granted by the borrower, a lender may require a guarantee or other form of comfort from equity investors.

Bilateral or Syndicated Facility
In a single bank (bilateral) facility the borrower's legal relationship will be with a single bank with whom the borrower will typically have had a longstanding relationship. In contrast, under a syndicated facility, a bank, typically referred to as the "arranger", will arrange for a number of banks to provide the borrower with funds. Whilst the latter arrangement has certain advantages, including reducing the borrower's reliance on a particular bank, one or more of the members of the syndicate of banks may have no prior relationship with the borrower and this may be problematic if subsequent waivers or amendments to the financing agreement are required. Issues which should be discussed with the arranging bank include:
- restricting which banks the arranging bank can approach.
- controls over the syndication process i.e. restrictions on the number of banks in the syndicate.
- "majority bank" controls in the documentation.
- control of assignments, transfers and perhaps sub-participations.

Hedging
A lender will wish to consider whether there is any interest rate risk if interest rates go above the assured level or currency exchange risk (for example if your debt is principally denominated in sterling whilst a material part of your cash flow is in pesetas). To protect against these risks, a lender may require certain hedging arrangements to be put in place. These in turn raise consequential issues. For instance if the interest hedging is a swap, then the counterparty will have a credit risk on the borrower for which security may be requested. If a cap is purchased, there is an expense (i.e. premium) which must be funded.

Constructing the joint venture - carried interests and incentives
You may well want to factor into the financing structure the value of the concept or invention that you are contributing. This is a matter for negotiation, but often investors will want to measure the value against the proven success, or lack of success, of the business. You may, therefore, seek a structure which will allow you to increase your proportional ownership of the business free of charge, or at a nominal price, dependent on investors achieving target rates of return. This may take the form of share options or the issue of shares with limited rights, which convert into more valuable equity shares depending on the success of the business. If you are responsible for the management of the business, similar structures may be used to give you a further incentive or reward for the success of the business.

New participants
Where there are only relatively few material participants in a joint venture, good relations between the material participants is often key to the success of the business. Initial strategic investors will have chosen to work together in the venture, but what if the working relationship does not work? Also, financial investors are likely to demand some liquidity for their investments. The financing structure should regulate the sale and purchase of shares or partnership interests in the venture. Commonly, in the case of a joint venture company, before an investor sells any shares to a third party, it is required to offer them first to existing shareholders. This may give existing shareholders an opportunity to shut out an unwanted investor, but allows a certain degree of liquidity for an investor who wishes to sell. Often this procedure will be supplemented by a requirement that, where an investor itself comes under the control of a third party, that investor must offer its shares to the existing shareholders. The constitution of the venture will similarly often require that new shares be offered to existing shareholders in proportion to their existing holdings before they are offered to outsiders. This allows investors to avoid being diluted. Similar provisions can be made in partnership agreements.

Further, if the business depends on the continuation of a franchise or licence, the constitution of the venture should probably provide that where the franchise or licence is put in jeopardy by the continued participation of a particular investor, the other investors may require it to sell in order to preserve the franchise or licence. This is common in the UK, for example, in the case of joint ventures holding television broadcast licences, the ownership of which is closely regulated.

Management
Although some investors may be willing to allow others to conduct the day to day management of the business, generally all investors will want a say on material matters, such as business acquisitions and disposals, material financings and other commitments and approving annual budgets - for example through a right of veto, weighted voting rights, or a shareholders' agreement. Where there are several parties to a venture, consideration will have to be given to how decisions are taken i.e. which ones can be made by management of the venture, which require a simple majority, and which require a greater majority, say, two thirds or seventy five percent.

Disputes and termination
It is important to ensure before entering into a joint venture that all parties have the same aims and expectations, in particular as to how it is managed and funded and as to how the participants obtain a return on their investment. Hopefully, this should avoid continual resort to any sort of dispute resolution procedures. However, as disputes do sometimes occur, procedures should be agreed in advance to regulate the resolution of disputes. For example, investors may agree that, in the case of a dispute which they cannot resolve between themselves, the matter should be decided first by the most senior people at the joint venture parties or, failing that, by an appropriately qualified independent third party. Procedures also need to be set up to ensure the business can continue to operate in the interim, for example the parties could agree they will maintain the status quo in the event of a disagreement or continue to apply last year's budget.

Investors may consider, however, that the only solution in the event of a dispute which proves incapable of resolution between themselves is to provide for the termination of the joint venture. If the venture is wound up, who will inherit the joint venture's property? This can be regulated in the joint venture documents. The ownership of the joint venture's intellectual property may be particularly relevant here. Alternatively, in a two party joint venture the parties' joint participation may be terminated by way of each investor having the right to offer to buy out the other party at a price specified by it and, if the other party does not accept its offer, to have the right to be bought out by the other party at the same price.

The participants in the joint venture may also consider it appropriate for the joint venture to be brought to an end if a participant is the subject of any insolvency event, ceases to carry on business or is guilty of material or persistent breach of the shareholders' agreement. In these circumstances, the shareholders' agreement or the company's constitution may entitle the other participants compulsorily to acquire the shares held by the defaulting participant.

Exit strategies
Strategic investors may be willing to sign up to a joint venture for an indefinite period. Financial investors, however, will generally want increased liquidity for their investment in later years and may, therefore, require the right to be bought out, to require a trade sale of the business or to work towards the listing of the joint venture's securities on a stock exchange.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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