Welcome to the seventh installment in our series of articles providing an overview of the various aspects relating to the venture lending industry in Israel, including some of the legal, commercial and regulatory factors that should be taken into consideration by anyone looking to enter into this realm. The main goal of this series is to equip readers with valuable knowledge and understanding of the venture lending landscape in Israel, helping them navigate and capitalize on the unique opportunities it presents, particularly for those looking to become stakeholders in the Israeli startup ecosystem. In our seventh installment below, we provide a high-level overview regarding certain matters to be taken into consideration already at the term sheet planning stage in connection with Israeli related lending transactions.
Venture lending transactions with an Israeli nexus require careful planning from the earliest commercial discussions through to the execution of the definitive transaction documents and the perfection of the security interests thereunder. Beyond the basic terms, such as the type of facility, interest rate, number and scope of the drawdowns and tranches, amortization schedule, fees and so on, the term sheet is the natural starting point to address several jurisdiction-specific issues that can materially affect timing and the scope of lender protection. To the extent that these issues are discussed at the term sheet stage this often leads to a more efficient documentation implementation process particularly for borrowers who are eager to complete in a timely manner.
Deal Structure
One of the first structuring questions is whether the Israeli entity should act as a borrower or guarantor. From a lender perspective, a borrower or co-borrower structure may provide stronger protection, as both the parent and relevant subsidiaries become parties to the principal transaction documents and may be directly subject to enforcement. That said, the inclusion of the Israeli entity as the borrower or co-borrower may carry certain tax and regulatory consequences. Conversely, from a Borrower perspective, a guarantor structure may be preferable, often for tax and/or corporate governance reasons. In cases where the Israeli entity is a subsidiary guaranteeing the obligations of its parent or a different entity further up the corporate group structure, such upstream guarantee runs the risk of being deemed a prohibited distribution under Israeli law and/or being deemed a dividend from a tax perspective.
To the extent that the agreed deal structure contemplates the Israeli entity being a borrower, it is also advisable to have the term sheet clearly state whether or not there will be full, partial or no tax gross up in connection with any amounts required to be deducted by the Israeli entity when it makes payments such as interest payments to the lender. It is advisable to reach consensus on this point prior to finalizing the term sheet, as this issue may substantially affect the economics of the transaction.
Beyond the co-borrower/guarantor structure issue, it is important to determine already at the term sheet stage, particularly with respect to situations where the borrower group is compiled of multiple entities, which entities will be providing collateral as part of the transaction. It is recommended to consider whether there should be an ‘excluded subsidiary’ concept, and if so, what a suitable threshold would be with regards to the value of such entities’ assets, above which they would be required to become a loan party and provide collateral. We acknowledge that such structuring may require some additional due diligence and costs at the planning stage, but if executed properly, this can result in a much smoother transaction. It should be noted that Israeli law requires withholding at source, but certain lenders may be entitled to preferential tax treatment – for further information regarding tax considerations, please refer to our third installment – Venture Lending in Israel – Tax Considerations.
Collateral Package
The scope of the collateral package should ideally also be addressed at the term sheet stage. In many Israeli tech companies, intellectual property is the company’s core asset, and unlike some U.S. venture lending practices, excluding intellectual property from the collateral package is very uncommon in the Israeli market. The term sheet should therefore clearly state whether intellectual property is included or excluded. In cases where intellectual property is excluded from the collateral package, it is common practice to include a negative pledge over such intellectual property and, in some cases, lenders request a springing pledge to cover intellectual property in the future should it be required to obtain control of proceeds resulting from intellectual property.
Moreover, as Israeli banks do not sign account control agreements as a matter of policy, a commonly negotiated point revolves around the amount that can be maintained in any Israeli bank accounts at any point in time during the term of the loan, the terms of which are generally bespoke to the specific parties. It is recommended to have these discussions already at the term sheet stage so that a balance can be reached between the operational needs of the borrower coupled with the needs of the lender to perfect security over cash.
Covenants and Information Rights
The term sheet should include some descriptions of the main affirmative and/or negative covenants that will be included in the main transaction documents. In particular, the term sheet should set out whether there will be any financial covenants or not, such as maintaining a minimum cash balance or minimum accounts receivable for a certain period of time. While the scope of covenants in transactions with an Israeli nexus generally track those of US deals, an example of a covenant with a specific Israeli nexus would be an undertaking by the borrower not to obtain funding from the Israeli Innovation Authority, or similar governmental authorities, without the lender’s prior consent. For further information regarding the Israeli Innovation Authority, please refer to our first installment – Venture Lending in Israel – Israeli Innovation Authority.
Moreover, the term sheet should also generally cover the scope and frequency of the various materials that the borrower shall be required to deliver to the lender throughout the lifecycle of the loan. This can include audited and unaudited financial statements, intellectual property reports, bank account liquidity reports, accounts receivable and accounts payable aging reports, projections, materials provided to the borrower’s board of directors and/or shareholders, and so on, as well as whether, and under which circumstances, the lender shall be entitled to appoint a non-voting observer to the board. It is worth noting that, particularly with regards to private Israeli companies, it can take several months to obtain audited financial statements for the preceding fiscal year, and these are typically only available during the third or fourth quarters.
Warrant Coverage or Participation Rights
The term sheet should also contemplate whether the borrower will be issuing the lender with a warrant to purchase ordinary or preferred shares of the borrower, as a form of equity kicker for the lender. In the case of preferred shares, the class and exercise price is typically the latest class of shares issued as part of the borrower’s most recent equity financing. As an alternative (or in some cases, complementary) to the warrant, the lender could be provided with the right to participate in the borrower’s next equity financing transaction. In both cases, the governing documents of the Israeli entity, particularly the Articles of Association, should be carefully reviewed to determine which corporate consents are required, as well as how to obtain waivers of pre-emptive and/or related anti-dilution protection rights of existing shareholders. It is worth bearing in mind that, in the event of the issuing entity being an Israeli corporation, the governing law of the warrant, and the definitive agreements in the subsequent equity financing transactions, would most likely be Israeli law, due to the underlying securities being those of an Israeli corporation. With that said, there is no issue having the main loan agreement governed by a non-Israeli law jurisdiction, while the warrant is governed by Israeli law.
About Us
Arnon, Tadmor-Levy proudly stands among Israel’s most prominent law firms, with one of the largest and most respected banking and financial services departments. We have extensive experience in cross-border and other complex financing transactions, representing both lenders and borrowers. Our trusted reputation spans a vast clientele, including leading Israeli and international banks and other financial institutions.
Our venture lending and private credit team is led by Simon Weintraub, Avi Anouchi and Idan Adar.
Should you have any questions, or are interested in learning more about the various aspects of the Israeli venture lending and private credit industry, please feel free to reach out to a member of our venture lending team, whose details are included below.
The above content is a summary provided for informational purposes only and does not constitute legal advice. It should not be relied upon without obtaining further professional legal counsel.
