2.4 Legal Risks Inherent in Funding Transactions 13In the capital market, listed companies have for various reasons used share-
boosting measures, such as share buybacks. For example, there may be pressure
from activist shareholders combined with a more effective market for corporate
control caused by private-equity groups. In addition, the use of executive stock op-
tion programmes may have increased share buybacks.
The other side of these trends was a reduction in transparency. First, more and
more instruments were traded outside regulated markets. Second, leveraged buy-
out firms and private equity funds used the money to buy public companies and
remove them from the stockmarket. In fact, 2006 marked the first in more than 20
years that European stockmarkets shrunk. Buy-outs, foreign takeovers, and debt-
funded share buybacks removed shares from stock markets faster than companies
issued them.^30
2.4 Legal Risks Inherent in Funding Transactions
Funding transactions can be legally complicated. Their legal aspects depend on the
form of funding (reduction of capital needs, debt, equity, mezzanine), the enter-
prise form of the firm, the category of investors, the particular aspects of the trans-
action, and other circumstances such as the governing law. The legal framework
that governs the funding transaction and the related agency relationships between
the firm and its various investors depends on the form of the funding.
However, at a general level, funding transactions are influenced by the same
general legal aspects as investment transactions. This is understandable, because
the firm’s own funding transactions can be someone else’s investment transac-
tions. In both cases, the firm will regulate four things: cash flow, risk, information,
and agency relationships.
Cash flow. In funding transactions, the firm obviously needs to manage the
availability and cost of funding. Key funding-related cash flow questions include:
access to funding; the mechanism of raising funds; the management of costs and
the mechanism of payment of costs; and the repayment of funds. The modalities of
the transaction are, to a large extent, determined by its structure. The cost of fund-
ing is influenced not only by agreements, but also by tax aspects and the account-
ing treatment of the transaction.
Risk. To the firm, the legal aspects of risk are basically the same in funding
transactions as in investment transactions. For example, there is a risk that costs
will increase, if they were not dealt with properly in the contractual framework, or
that the contract will be interpreted to the detriment of the firm (see Volume II).
Some legal risks are characteristic of funding transactions. The most important
of them relate to the availability and withdrawal of funding (the investor’s exit),
default, cost, and the power of investors to influence the management of the firm’s
business.
(^30) Ibid.