♨️ 📇 🔩 Financial nuance in the project agreement of the IT project 🌙 👩🏽‍🎨 👩🏿

A lot has been written and said about broken spears during the initial attraction of financing at the zero stage of the IT project. In this case, the main interest is the consideration of the process of interaction and conflict resolution among the main participants in the project during its implementation.

1. Change of investor-partner: flew away, but promised to return

Investors come to projects at different stages of implementation and with different strategies. The initial investor, who was still present in the project at the research and development stage, can attract another investor to invest in the project’s own capital almost before raising borrowed funds. The main objective of the investor, in this case, is the sale of shares / shares in IT companies and receiving compensation for taking the highest risk; an alternative would be to receive financing from a second investor with a higher rate in order to compensate for the costs incurred on the project.

The second investor may not have the desire or ability to bear the high level of costs and risks associated with the implementation of the project at the research and development stage, and, accordingly, will buy shares / shares in IT companies from the initial investors from the moment the successful implementation begins, at a higher a price that reflects a lower degree of risk and profitability.

There is one more important nuance: equity may not always be provided by investors in the form of shares / shares. It is often more profitable for investors to provide in the form of a loan. This method avoids the situation, which is known as the "dividend trap." In addition, this method simplifies the procedure for returning funds to investors in case of refinancing or at later stages of the project, when investors decide to return their investments.

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Quite often, several lender pools participate in the project: private capital, banks, funds, leasing and factoring companies, etc.

Each of these pools will enter into its own agreement with an IT company (even if the agreements are standardized, as the crowdfunding format suggests [1]) , but the pools that provide financing need to create a mechanism of interaction to coordinate the activities of all creditors, otherwise the project will be decomposed.
Interaction agreements, as a rule, include assurances and guarantees, agreements, a general repayment schedule and priority for using cash flow, a list of insolvency facts, an agent for all creditor pools, voting and collection procedures, and collateral documentation.

Also, if the lenders are represented by different jurisdictions, the financing agreement and the cooperation agreement based on the same traditional legislation mitigate the risk of different interpretations of contractual language.

There remains a possible risk of problems between different pools of lenders if the debt principles are based on different financing principles (fixed or floating rate loans, leasing, factoring, subordinated or mezzanine financing, etc.).

So, for example, in order to accelerate the implementation of innovations and at the same time reduce the financial burden on the company, some large vendors offer financing services for complex IT projects using their own systems and equipment [2].

In this case, if the IT company finances part of its project costs (using the IT infrastructure) through leasing or long-term leases, then often the equipment is owned by the lessor (lessor). Other lenders will object to the fact that the lessor (lessor) alone manages the key components of the project infrastructure.

The same situation may arise if the IT company uses the Islamic financing model (equity financing) to pay off part of the costs of the project [3]. The key characteristics of this type of financing are the absence of interest payments, and, therefore, fees for the use of an asset (analogue of leasing) may be charged. In such cases, the right of ownership of the asset remains with the creditor (retains the title), and, as a result, the possibility of material and legal protection of their rights in case of failure to fulfill or improper performance of the obligation on the part of the IT company [4].

If the IT company attracted subordinated or mezzanine financing, then in the first case, lenders will require investors to admit that they have no right to security and cannot apply law enforcement measures or put other obstacles in the way of senior lenders until their loan will not be repaid; in the second case, with limited resources for cost recovery, problems can be associated with possible dishonest behavior on the part of mezzanine lenders, who may threaten to divide the project into components if senior lenders do not share part of the funds with them [5].

Thus, if there is a pool of creditors, a decision-making mechanism must be developed, otherwise one or two unscrupulous creditors can negatively affect the common cause by taking separate actions with respect to the IT company, imposing actions that are not consistent with the majority’s desire.

3. Collateral for creditors: with a black sheep, at least a wool tuft

Lenders do not consider returning financial investments for themselves by selling the assets of an IT company, since in most financing transactions in the IT sector, only monetization from the successful operation of the project will be able to provide a return on their funds. The transfer of ownership of project assets very rarely solves the problem in case of failure of the project.

However, collateral for the entire project allows securing lenders in the absence of positive results in the project, ensuring that third parties do not receive priority or equal rights in relation to the project assets.

Typically, collateral in an IT project includes:

project cash flow control;
the ability to intervene in project management;
distribution of rights to contracts concluded on behalf of an IT company;
pledge for shares / shares of an IT company.

However, problems may arise between investors and lenders regarding the rights of the latter with respect to securing for all contractual rights and guarantees that the IT company has. Especially if it is necessary to attract third parties in the process of creating collateral or increasing the effectiveness of the project, for example, there may not be consent to the allocation of rights for participants in project contracts.

Typically, lenders receive shares / stocks of IT companies as collateral. This allows lenders to more quickly intervene in the management of an IT company. However, certain difficulties may arise, for example, lenders providing financing for investors may fix a “waiver of collateral”, after which investors should not use their assets as collateral for third parties. This may prevent the use of shares / shares of the IT company as collateral.

Investors may be forced to discuss the waiver of such provisions in relation to their shares / shares of the IT company. There are many different ways to solve the problem associated with the collection of collateral for shares / shares, for example, lenders can take the buyer's option on the shares of the IT company.

One way or another, this may give rise to problems in interacting with investors regarding the transfer of obligations to control the actions of an IT company to the creditors' responsibility zone if they participate in its direct management. In addition, lenders exercising continuous control, in turn, can be recognized as “shadow directors” responsible for the obligations of IT companies in relation to third parties.

4. Assurances and guarantees of investors: escape is death

Lenders, as a rule, are interested so that the IT company does not suffer in the event of financial problems or bankruptcy of investors, who, in turn, would earn income from their investments, which should serve as an incentive for them to continue to fulfill their obligations regarding the project. If it turns out that investors receive a low rate of return, then lenders may assume that investors compensate their costs in the project in another way.

Therefore, investors may be required to provide representations and guarantees directly to creditors; in this case, investors may be liable for the loss of creditors as a result of incorrect assurances. Also, investors can independently provide lenders with guarantees of invariability of property rights in IT companies.

If the commercial risk inherent in this project is not adequately compensated, investors can provide additional assurance that they intend to maintain their property rights in IT companies. Investors can also take on some limited liabilities to offset risk that is critical for lenders.

Such guarantees may include: liabilities for a partial increase in equity, guarantees for the financial viability of the project, guarantees for the reimbursement of previously paid dividends, guarantees for interest payments, guarantees for the reimbursement of cash flow deficits, guarantees for maintaining the management structure, etc.

5. The facts of the insolvency of IT-companies: to whom I owe - I forgive everyone

Lenders may include in the loan contract with the IT company a change in the material terms allowing them to refuse to carry out the transaction in the list of insolvency facts, which increases the uncertainty for the IT company and its investors.

If the IT company agrees with this position, then the events that may serve as an occasion for creditors to abandon their obligations must be precisely defined. Such events should affect the ability of the IT company to operate, the financing conditions or its ability to service its debt or make payments to creditors, which, in turn, may include “potential insolvency facts”, thereby providing additional guarantees. This condition must be acceptable for the IT company, i.e. it is obvious that the likelihood of such events is quite high.

For some facts of insolvency, it is possible to establish restrictions; for example, inconsistencies in warranties and representations must be significant; or, for example, if the IT company is not able to fulfill the agreements for reasons that are considered by creditors to be valid, a temporary or permanent refusal to fulfill them may be accepted.

Lenders and investors always assure that they will not automatically use the facts of insolvency to leave the project and that they are only interested in long-term cooperation; but, as practice shows, as soon as the fact of insolvency is fixed, the IT company will be in a very disadvantageous position.

6. Refinancing of the project: no attracting to pay

Refinancing after the launch of the project can be carried out in order to raise funds on more favorable terms or, conversely, refinancing may be necessary in a situation of default.

However, refinancing often creates a number of problems for partners, as investors are able to recover most of their initial investment, in which case their financial interest in the future success of the project is limited.

A difficult situation also arises if the IT company wants to conduct partial refinancing, part of which is another debt obligation, since in this case there are contradictions between the lenders. If the conditions allowing such an operation were not agreed in advance, then the original lenders will have the opportunity to put pressure on the IT company and force it to redeem their consent for refinancing.

In addition, refinancing can create prerequisites for problems with a state contract partner in the framework of the project agreement due to the fact that it is quite difficult to determine the reason for the sudden refinancing.

[1] New tools for attracting financing for the development of technology companies: use practices and development prospects in Russia // Center for Strategic Research - 2018.
[2] Financing IT projects // www.croc.ru/solution/services/financing/;
Leasing of IT equipment and software // store.softline.ru/leasing .
[3] Islamic banking. Share financing industry // www / tadviser.ru / a / 253212 .
[4] Analytical report “Loan agreements and loan agreements. Islamic Law ”// ANO“ Center for International and Comparative Legal Research ”- 2018.
[5] E.R. Jescomb Principles of Project Finance, - Moscow: Top, 2008.