United States: A Practical Guide To Professional Sports Investments

Once investors find the right fit, sports can be an exciting addition to a diversified portfolio and provide a significant long-term return to those with the fortitude to be patient.

Of all the alternative investments, owning a professional sports team is one of the most coveted and elusive. Supply is scarce, valuations have exploded over the past two decades, and demand from the high-net-worth community outpaces supply considerably. Sports investment options are also starkly different than other alternatives – like art, real estate and hedge funds – both in the way they should be analyzed, and in the mentality required for a healthy return.

How does a sports investment differ?

Owning a sports team is both exciting and challenging, especially for investors who use rigorous and objective analysis to inform their investment decisions – such as hedge fund and private equity fund managers. One reason is that sports investments are partly objective and partly subjective. The objective part – items such as cash flow from sponsorships, payroll expenses and debt service costs – can be studied and predicted.

However, success often depends on variables that are not easily controlled. For instance, a baseball general manager can use objective sabermetrics to evaluate players, but whether or not those players "gel" on the field is almost impossible to predict. Likewise, a huge free agent signing, which was expected to increase ticket and merchandise sales could turn out to be a bust. Investors need to be prepared for operating within this subjective world, and be ready to constantly evaluate whether winning on the field, or winning on the balance sheet is a higher priority.

In addition, very few teams are cash flow positive. From an investment perspective, you should be prepared to put up a fair amount of money, typically via capital calls, to support the ongoing operation of the team, in the hopes that valuation increases will give you a very strong multiple on your investment when you exit the deal.

Being part of an ownership group

Unless you're a billionaire, you're probably not buying a MLB, NBA, NFL, NHL or MLS team on your own – you will be a part of a syndicated ownership group.

When an ownership group has many limited partners, you're really betting on the abilities of the general partner. In those situations, your due diligence should focus on that person and the team's financial prospects. Being a limited partner with a small stake is often a more passive investment, and many prefer this approach when doing their first sports deal.

Your other option is to join an ownership group with a few relatively equal investors. These groups typically consist of people who have had significant success in their chosen profession, whether in business, entertainment or as fund managers, who are now jumping into sports. Some of them will view sports as a trophy investment, while others will be activist owners who want to be involved in the team's day-to-day operations.

Before you join one of these syndicates, it behooves you to do a considerable amount of due diligence on your potential partners, and clearly understand the partnership structure and operating plan. That way you can ensure that your partners share your temperament, and your vision for operating the team and increasing its value.

The importance of corporate governance

Equally important is a clear delineation of responsibility among owners. That includes choosing someone to serve as the delegate to the league's governing body, and deciding how decisions get made within the ownership group. For example, who's responsible for determining the team's payroll, making player decisions, or pursuing stadium construction projects? Are you delegating those tasks to a paid employee, such as a general manager, or will a committee of owners oversee them? These corporate governance concerns are no different than those of your typical closely-held corporation. The way you address them and promote stability is with a strong operating agreement and a clear explanation of responsibilities among the syndicate members.

Avoiding friction among owners

Even if you have a strong operating agreement, great management and a clear delineation of responsibilities, friction may arise. When you're winning games and breaking even, or even winning games and losing a small amount financially, most owners are fine. But when you're losing games, and getting frequent capital calls, most owners will get disgruntled. Friction can also arise when a passive owner suddenly decides to become an active one. Similar to other activist investors, these investors can bring about positive changes that add value, or negative changes that lead to turmoil within the ownership group – turmoil which can quickly escalate and devalue a franchise.

Where are the opportunities?

When applying to colleges, applicants have their reach school, their hope school, and their safety school. For most sports investors, the NFL, MLB and NBA are their reach options. But skyrocketing valuations have taken these leagues off the table for all but the uber-wealthy. Moreover, these leagues often put strict limits on the number of owners – to avoid ownership drama and promote stability – thereby limiting opportunities for high-net-worth investors looking for a small piece of a team.

The hope options are most likely NHL or MLS franchises with current valuations in the $200 million to $1 billion range for NHL teams and less for MLS clubs.

For those looking at "safety" options, minor league baseball franchises can be very compelling opportunities. Most teams are valued at anywhere from $10-$40 million, which means there's flexibility to buy a team outright, or to syndicate ownership among many investors. Active investors can do very well here, partly because the affiliated major league team covers the minor league team's player salaries. That means investors can manage their costs and focus on revenue-driving activities, such as creating a great fan experience, which drives ticket, merchandise and concession sales.

Overseas soccer teams, particularly in Italy and outside the English Premier League, also present interesting opportunities.

Shepherding you through the process

On the surface, buying a sports team may seem like a regular M&A transaction. However, these deals often have complicated twists that require extensive due diligence and the guidance of advisors who are well-versed in sports business, have established relationships with the leagues to facilitate negotiations, and have helped investors exit previous investments when conflicts arise.

Once investors find the right fit, sports can be an exciting addition to a diversified portfolio and provide a significant long-term return to those with the fortitude to be patient.

Originally published by WealthManagement.com.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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