Football Governance

Written evidence submitted by Olswang (FG 57)

Submission to the Enquiry into Football Governance

1. Olswang conducts M&A in a variety of sectors, including media, technology, leisure, entertainment and retail more recently has focused its energies on acting on the sale and purchase of football clubs, particularly those in the Premier League.

2. Over the last twelve months, we have been retained to act on the purchase (and sometimes sale) of several Premier League and Championship clubs.

3. During this time, we have conducted legal and commercial due diligence on a number of clubs, spent time negotiating with the high street lenders, reviewed financial due diligence reports from the main reporting accountants to clubs in England, talked to owners and prospective owners, negotiated with the key corporate finance advisers in the football industry, had numerous discussions with interested journalists and worked alongside the key football based insolvency professionals.

4. We have also acted for a large listed Premier League club for many years in relation to its corporate and commercial needs, including acting on public fundraising transactions as well as advising on a variety of media and rights based agreements and believe know what a well run and adequately funded club looks like and how such operates.

5. Thus we have what we hope will be a valuable insight into the football industry.

6. Given that all of the sale and purchase processes in which we have been involved concerned clubs that have been in varying degrees of distress, our comments only apply to such clubs.

7. It should be noted that in addition to the above, Olswang provides commercial legal advice to several of the larger Premier League clubs and we stress that such clubs are materially different to the clubs we have diligenced in that they have financial and corporate governance systems in place, are managed by professional non-football persons and, importantly, are run within their means.

8. However, in relation to the business affairs of the troubled clubs we have reviewed we set out the landscape that we discovered below.

9. Without a radical overhaul and a rethink about how football is funded and managed in this country, we are concerned for the long term health and viability of the industry.

What we have found

10. The common denominator of the troubled clubs we have diligenced over the past twelve months is, without doubt, a chronic shortage of working capital coupled with an ever diminishing set of options to raise further cash, which leads to a state of perpetual crisis management; rendering it difficult for incumbent management to operate the business in the medium to long term.

11. The characteristics of the businesses we have reviewed are set out below.

Funding

12. We found that the way that clubs had raised money in the past and secured such borrowings was not really appropriate for the type of cash flow business that a football club operates nor for the type of assets that a football club has.

13. We found that senior lenders had typically taken fixed and floating charges over the assets of the club (including the stadium) which resulted in the club being unable to properly use their assets to secure further cash flow requirements. By this, we mean that in return for a senior lender advancing, say, £20 million of funds, the lender has been granted a charge over all of the club's assets (which may be significantly in excess of the funds loaned) but, going forward, the lenders have been extremely reluctant to relinquish any "spare capacity" in their security package to allow the club to secure other much needed borrowings. This means that club's borrowings have typically been inefficiently structured.

14. This means that clubs in such a position have been unable to raise further capital using traditional banking means (as subsequent lenders were not prepared to lend without having adequate security) and thus the avenues open to clubs that have exhausted the traditional banking sector are relatively high risk and high cost in nature.

15. Further, whilst clubs offer up their stadium as security, this is not particularly useful security for a bank as, in the event of a default, it is unlikely that the bank will willingly step in to take control of the stadium, tear it down and sell the land to, say, a supermarket chain to recoup their losses. Stadia tend to benefit from bespoke planning permission, meaning that there is little alternative use for the property.

16. Many clubs have resorted to securitising or forward selling their future rights in order to obtain desperately needed short term cash. This involves receiving cash today for future revenue streams such as next year's season ticket sales, next year's shirt sponsorship funds, future years' catering contract revenue and so on. In every situation we looked at, clubs were effectively selling next year's revenue to pay this year's (or last year's) debts. Such a business model is of course not sustainable in the medium or even short term.

17. As a result of a desperate need for cash, we typically found that senior management's attention was almost solely focused on raising short term cash to meet immediate debt demands from, in particular, HMRC but also the club's football creditors, trade creditors etc. This led to an inevitable downward spiral and an inability to plan for the long to medium term needs of the business or the ability to create new forms of commercial revenues to support the club in the long term. Long term planning was a luxury that the cash flow needs of the club did not permit the management the time to worry about.

18. This has led to the practice of using cash set aside for HMRC as working capital for the club. In any other industry, this is an incredibly serious offence that typically leads quickly to a winding up petition and personal consequences for those involved. Based on anecdotal evidence, this seems to be a relatively widespread practice in football, with HMRC being owed more than £20 million by Portsmouth for instance. Whilst we have noticed a marked reduction in patience by HMRC in relation to unpaid PAYE and NICs since the Portsmouth situation, the fact that this practice was widespread in football is evidence of the parallel universe that has long surrounded the operation of a football club in this country. Many clubs appear to operate outside the accepted commercial and legal boundaries that other businesses must adhere to.

The business model

19. We began to realise that one of the key issues with clubs we were reviewing was the fact that, unlike every other sector of business (outside the charity sector) in this country, the main aim of most football clubs is not to make a profit. For that reason, profits are rarely heard of in the industry. The purpose of a football club is actually to achieve an on field footballing performance which is commensurate with the expectations of the fans and the owners.

20. This leads us to wonder whether, for the vast majority of football clubs in the country, the use of a limited liability company really is the correct vehicle.

21. We believe there may well be a better model under which all but the upper two tiers of football in this country are owned via a different model of ownership, such as a community interest company ("CIC"), a company limited by guarantee or an incorporated association where the aims of the entity are non-profit related, where ownership can be widespread and community based and where the club can be better integrated into the structure of a community.

22. In Australia for instance, most of the rugby league clubs are owned by companies limited by guarantee where the members (i.e. the local fans) are members of a licensed local club (called a "Leagues club") that raises funds for the team via traditional leisure and hospitality offerings (restaurant, bar, nightclub, hotel etc) that generate revenue to cover running costs of the Leagues club and the balance is then ploughed back into the team. The key is that such clubs are not for profit, can enjoy special tax status and provide a very useful social bonding effect within a community.

23. We would welcome further consideration of the CIC model being discussed by the committee.

The nine point deduction rule

24. Given that our experience to date has been predominantly based on acting for potential purchasers of clubs, it appears to us that the best way to encourage the efficient passing of control between underfunded clubs to better capitalised new owners is via the administration, CVA or insolvency process.

25. At present, in order to purchase a club, there are a number of stakeholders who are owed money (typically including the banks, the directors, the owners, the football creditors, bond holders as well as trade creditors) and on a solvent basis, it is incredibly difficult to secure a deal which satisfies the needs of all such stakeholders, particularly when the banks (who generally are actually the legal controllers of the clubs) are keen to encourage the sale to be seen as a process instigated by the owners, meaning that you are negotiating with owners who are desperately keen to argue there is equity value in their personal positions when generally, there is not.

26. In every other sector, the major creditors of a troubled business would merely appoint an administrator who would assume executive control, assess the merits of the business and merely decide to sell or wind up the business. This does not happen in football nearly as much as it should and we believe the key impediment to such is the nine point (ten points in the Championship) deduction rule.

27. "Men of football" will tell you that this is a vital rule designed to punish clubs that spend beyond their means and try to "buy promotion". Whilst there is some merit to this, we believe that the nine point deduction rule (and their equivalents in the lower leagues) is actually acting as a potentially harmful impediment to what should be a much more orderly transfer of control and should be suspended to enable the sort of restructuring that is occurring in almost every other sector in the country, other than football.

28. The nine point rule was designed to give the administrators of the game a stick with which to beat clubs to encourage them to stay on the financial "straight and narrow". The policy behind the rule is that by imposing such a drastic footballing consequence on a company operating a football club, such entities either followed sound and responsible financial practices or suffered the unfavourable football and business consequence of losing hard won points, which may lead to the ultimate punishment, relegation.

29. Thus, the rule was designed to incentivise clubs to ensure they operated solvently, that they were able to pay their debts as and when they fell due and to ensure that they managed their businesses and finances responsibly and did not let their debt positions get out of control.

30. We believe that the rule is not currently acting as an effective deterrent. The influx of significant amounts of cash from the sale of media rights, the lack of any salary cap or downwards salary pressure on players' wages across Europe, the perceived need to sign the world's best players in order to maintain competitiveness and thus maintain sponsorship, media rights and other commercial revenue streams and the lack of consistent standards of financial management and corporate governance that you might expect from businesses with multi-million pound turnovers has meant that several clubs have reached a point where without the ongoing support of their creditors, there is no obvious way for them to avoid insolvency.

31. Practices across many top flight UK football clubs have become grotesque when compared with normal business benchmarks; for instance the almost universal rule of thumb is that salary costs should never be greater than 33% of a group's turnover. Against this, figures of 70% and above are not uncommon in the Premier League. In fact, the recent UEFA report into football finances identified 57 clubs whose wage bills equated to 100% of turnover and also found that 56% of all European footballing debts reside within the Premier League. The figures speak for themselves.

32. Given the draconian consequences suffered by Premier League clubs such as Portsmouth in 2010 as a result of appointing an administrator, boards of directors of other clubs are loath to follow the same steps in similar circumstances. This leads to clubs continuing to trade, risking allegations of wrongful trading and personal liability for the directors, rather than going into administration. A footballing consequence should not discourage a board from complying with the law and potentially causing unnecessary additional losses to creditors. As a result, clubs never properly deal with their debt burden and enter into a vicious cycle of spiralling debt which, if left unattended, leads to the situations that clubs like Portsmouth and others have found themselves in.

33. Further as the new UEFA financial fair play regulations come into force, it will become clear that if the Premier League wants their members to be participating in Europe, many of their members will need to radically restructure their debts; and quickly. Administration may well be one route to achieve such.

34. Thus, we are concerned that rather than encouraging clubs to adopt sound financial practices, the nine point rule can operate to positively discourage the boards of clubs from taking advice and where appropriate appointing administrators, which is what the law may require when a club is no longer able to pay its debts and is what many clubs need to do in order to address their unmanageable levels of debt.

The fit and proper person test

35. We note that you have asked for views on the effectiveness of the fit and proper person test.

36. Whilst we note that the Premier League has widened the range of offences that are relevant for consideration before granting consent, we believe that the key aspect that is not dealt with is not the character of the new owner, but the financial wherewithal of the new owner.

37. Surely the test should be, in addition to the present matters, whether or not the new owner has the financial ability to place the club in a better situation by repaying debt and putting in place a sustainable business plan for the club going forward. Any new owner must deal adequately with historical debt.

38. Whilst circumstances may change for an owner (as was the case in relation to West Ham's Icelandic owner for instance), there are clearly owners who have taken control in circumstances where they never had the financial resources to deal with the club's financial difficulties.

39. Indeed, we often here the phrase "all you need is £x million to nick the club" which is generally the smallest amount possible to get the banks to agree to lift their charge and allow the shares to be sold to the new owner.

40. Thus, we believe the business plan of a new owner should be vetted by the Premier League in parallel with their fitness for occupying a board seat at the club and a plan to significantly reduce debt should be a pre-requisite for the gaining of consent.

Attachment 1

Specific questions

· Should football clubs in the UK be treated differently from other commercial organisations?

We see no valid argument in favour of football clubs deserving special treatment. Ultimately, it is a game that is loved by many in this country, but, nonetheless, as a corporate entity with debts, creditors, employees and staff, clubs should be treated no differently from any other operating business in the country.

Any business that does not meet its HMRC obligations, that trades whilst insolvent, that does not pay its creditors nor its lenders is not viable and the laws of the land deal very efficiently with such businesses.

Rules such as the nine point rule and the football creditors rule ensure that football and the football industry operate outside the laws of insolvency which should not be tolerated any longer.

· Are football governance rules in England and Wales, and the governing bodies which set and apply them, fit for purpose?

Given the size of the businesses in the top flight of football, thought could be given as to whether the principles of the UK Corporate Governance Code (formerly the Combined Code) which sets out standards of good governance in relation to board constitution , remuneration, accountability and relations with shareholders for listed companies, should apply to football clubs, particular ly those in the top two flights of the game.

All companies with a premium l isting of equity shares in the UK are required under the UKLA's Listing Rules to report on how they have applied the UK Corporate Governance Code in their annual report and accounts and perhaps this can be applied to football as well.

Alternatively, perhaps a more gentle approach might be similar to that adopted by companies listed on the AiM market of the London Stock Exchange which are encourage d to compl y with the corporate governance guidelines of t he Quoted Companies Alliance which are aspirational in nature and represent best practice. The better run companies thus tend to comply with the guidelines, particularly those seeking investment from serious institutional investors.

If clubs want to attract investment from third parties, pension funds and fans alike, the first step would be to do what any other company in the country does, namely, put in place an impressive management team, adopt a business plan that is professional and which demonstrates an ability for the club to manage its cashflows, have a blend of non-executive and executive talent on the board, put in place robust and transparent governance and reporting structures as well as document its affairs in a professional and organised way.

· Is there too much debt in the professional game?

Whilst every club is different and there are wildly differing issues and owners, certainly the clubs that we have diligenced have been saddled with levels of debt that were utterly unsustainable and in relation to which they had limited prospects of being able to service out of their own cashflow.

We would support a change in emphasis on using equity to fund clubs going forward, in particular equity supplied by supporters. We have seen structured financial products in the market that could easily be adapted to the football industry that would access SIPP investments from fans for instance.

We have a number of interesting ideas about how to move away from the debt funded model.

· What are the pros and cons of the Supporter Trust share-holding model?

We do not have sufficient information on the supporter trust shareholding model to pass meaningful comment.

However, we suggest that CIC's, particularly for lower league clubs, may well be a very useful model to encourage clubs to adopt. A CIC is formed primarily for social enterprises that are being carried out for the benefit of a community and this remains the primary focus of the company for as long as it remains in existence.

Importantly, the Companies Act 2006 permits the use of CICs already so no legislative change is required. CIC's are not for profit, provide the directors and shareholders with the benefit of limited liability and their primary purpose is to pursue activities designed to benefit the community, which is a core principle incorporated into the legislation and set out in terms of the "community interest test".

We would be happy to discuss further the merits of the use of such entities. We also believe that creating a licensed club within the community that is linked to the local club and funds it, much as the way that rugby league if funded in Australia for instance, is a model worth considering.

· Is Government intervention justified and, if so, what form should it take?

This is a difficult issue and one that we have not developed an agreed position on.

One could argue that, in order to lift standards of corporate governance in the football industry, all that is arguably necessary is for the full force of the law to be applied to the football industry in the same manner as it does in other sectors.

This would ensure over time that good governance was rewarded and bad governance punished. We are strong advocates of ending any perception that football be viewed as a special asset class where the normal rules do not apply.

For so long as proper standards of corporate governance, such as a majority of non-executive directors, independent chairman, employing a qualified finance director, adopting and complying with written policies (eg: the Bribery Act) and the use of committee structures similar to listed companies, are not commonplace in football, it is difficult to imagine the industry recovering to benchmarks set by better run industries.

New management, possibly with non-footballing backgrounds, are desperately needed to enter into the industry, in particular, those with no great love or affinity of football, merely the skills, experience and talent to assist to put in place proper systems and follow best practice.

Apart from an influx of new managerial talent and an increased emphasis on corporate governance, the Government could help by announcing its intention to apply the full force of the law to clubs.

This would mean HMRC aggressively pursuing clubs that withheld PAYE and NICs payments, the FSA pursuing directors that allow their clubs to continue to trade whilst insolvent and passing legislation to render inoperative the football creditor rule in insolvency situations. Every other industry is subject to these realities, so should football.

Another option, and one that we also have sympathy with, is that without central leadership and specific intervention, it is unlikely that the football industry will change from within and if it does, that change will take too long.

We would be in favour of a super regulator being implemented to be responsible for football in this country; one that policed the game much in the same way as the UKLA and FSA policies those entities admitted to trading on the London Stock Exchange.

In order to ensure that the regulator was not politicised or, perhaps to ensure that politicians did not baulk away from taking these necessary steps for fear of voter backlash, perhaps the regulator should be an independent body both in management and funding (and funding could be achieved via a levy paid by clubs or indeed the Premier League and Football Association for instance).

The role of the independent football regulator could be many and varied. Whilst we acknowledge that there may not be a great appetite for additional public bodies during these austere times, the regulator could:

· Governance: taking its lead from the Combined Code and QCA Guidelines, create corporate governance, financial and commercial benchmarks and levels of expectation about how the game should be run in the UK and bring about changes in the way it is administered and governed so that the football industry was sustainable and financially viable in the long term and, perhaps, with an aim of making it more likely that the national team was successful;

· Compliance: require each club to have a compliance adviser (which could be a law firm) whose role it would be to independently assess the management of a club against best practice corporate governance criteria and report back on the administration of the club against a set of acceptable corporate governance and financial benchmarks;

· Licensing: consider putting in place and then administering a licensing scheme for instance under which all clubs in the land would be required to satisfy an ever increasing list of criteria that would focus on corporate governance and sustainable operating practices;

· Regulate FA: regulate the affairs and policies of the FA and, in so doing, seek to overhaul its administration, rules and promote levels of corporate governance in the game;

· Financial management: take steps to restructure the finances of the game in the country or – as we suggest – introduce gradual changes to the football landscape towards a more sustainable and financially viable game;

· Restructure of football: acknowledge that perhaps there are perhaps too many clubs and not sufficient funding available for all football clubs to continue in the UK indefinitely. If that premise was accepted, the Regulator may well oversee the gradual transition of football into a new smaller, sustainable two tiered model. This might involve for instance:

· creating a permanent division between the top two divisions of football in this country and the remaining divisions, thus ending the romance of a third division club making its way into the Premier League;

· this would be done gradually by putting all clubs on notice now that promotion and relegation into the Championship will cease in five years time;

· once that five year period was over, for the next three years, the bottom three clubs in the Championship could be permanently relegated (thus shrinking the top tier of football in the country to a more manageable and financeable level);

· clubs could be incentivised to merge or be wound up or convert to CIC entities across the country.

There are obviously many other roles that a regulator would or could play in football. The above represent merely a few suggestions which we would be only too happy to expand upon should you wish.

· Are there lessons to be learned from football governance models across the UK and abroad, and from governance models in other sports?

No comment.

January 2011