It often happens that a start-up business is unable to raise start-up capital in the conventional financial market.
Banks and other conventional lenders often find the risk profile of a new business with no reliable track record unattractive. Not only is the viability of the new business unproven, but the new enterprise often faces regulatory hurdles that may inhibit its entry into the market.
To find start-up capital, entrepreneurs must turn to the less conventional sector of the financial markets, where lenders and investors have a greater appetite for risk provided that the entrepreneur is prepared to accept higher finance charges and more onerous finance terms to compensate for the increased risk.
These onerous conditions take many forms. The financier could charge a high interest rate or could take a stake on terms which ensure participation in the upside, but no risk in the downside of the new business.
It is common practice for financiers to build early triggers into their financing terms. That enables the financier to pre-empt the repayment of the loan or the investment, or to take early steps to intervene in the management of the business or to convert into equity if the business should show signs of failure.
Triggers are normally set off by the failure of the business to achieve or maintain financial covenants such as profit margins, profit targets, debt cover ratios and the like.
Case in point
In the recent unreported case of HCI Invest 15 Holdco Proprietary Limited and another vs Ithuba Holdings Proprietary Limited (RF) and others in the Gauteng Division of the High Court (Johannesburg), HCI had entered into a suite of agreements to provide part of the start-up funding to Ithuba when it was granted the national lottery licence in 2015.
The agreements provided that on occurrence of an early trigger event, HCI would, among other things, acquire certain oversight or step in rights over the business of Ithuba. These rights included the power to appoint and remove directors and employees of Ithuba and to exercise unfettered control over the conduct of Ithuba’s business.
What had not been foreseen when the agreements were drafted, was that the far-reaching oversight and step in rights that HCI would become entitled to exercise upon the occurrence of a trigger event, would constitute a large merger as contemplated in the Competition Act, 89 of 1998.
That had the unintended consequence that when HCI became entitled to exercise the rights which were designed to enable it to step into the business of Ithuba to protect its investment, it was unable to do so because a large merger may not be implemented unless it has been approved by the Competition Tribunal in terms of the Competition Act.
Far from affording it the intended quick access to the business to protect its interests, the step-in rights granted to HCI are the subject of complex merger proceedings and HCI will have to wait for these proceedings to play out.
The inadvertent merger?