By Andrew Rocks, Ben Stein, Andrew White, and Kelly Cooke, of Morgan, Lewis & Bockius LLP
Sports franchises and other sports-related businesses have emerged as a legitimate and rapidly growing asset class. In recent years, sports franchise values have continued to increase dramatically. These increases, combined with growing investor demand to get into the game, have resulted in substantial investment in this sector. While investment opportunities have traditionally been accessible only to ultra–high-net-worth individuals, many major sports leagues and their member teams around the globe are opening their doors to investment from financial sponsors and institutional investors.
The easing of investment restrictions permitting ownership positions by private equity investors has led to a rise in private equity funds dedicated to sports investments. Most major US sports leagues have modified ownership rules to allow for the possibility of private equity holding a minority ownership interest in their teams. Major League Baseball (MLB) became the first US professional sports league to allow private investment funds to hold passive, minority interests in multiple teams in 2019. Since then, the National Basketball Association (NBA), Major League Soccer, and the National Hockey League have followed course (with the National Football League (NFL) as the notable exception, although even the current NFL restrictions appear to be a topic of reconsideration). But the rules around private equity investment in these leagues have pushed funds to fundamentally change how they operate in order to get their foot in the door.
In any significant franchise transaction, most professional US leagues have significant approval, oversight, and information rights; will expect to perform significant due diligence on the new owner(s); and will often have approval rights over the definitive transaction documents. For example, in the NBA, the permission process starts with an application to the commissioner, which is sent after the deal parties have come to an agreement on the terms. As a general matter, private equity firms will guard against the incurrence of any significant out-of-pocket costs prior to having some level of certainty of the likelihood of the deal being consummated. Moreover, the transferring owner must provide the commissioner with all information that he requests regarding the transaction, and the cost of the commissioner’s review is charged to the transferor/transferee owner. This “reverse diligence” is traditionally strongly resisted by private equity firms in other contexts. Leagues conduct deep probes into potential buyers and an interest in their teams, whereas buyers are often afforded a limited view into financial information and not much else.
Another unique feature of sports investments that conflicts with standard private equity protocol is the typical investment time horizon and the interaction of certain requirements around there being a single “controlling owner.” Private equity funds are traditionally structured under their limited partnership (LP) documents to undertake an exit event and realize a return on investment (ROI) for their LPs on a limited time horizon of five to 10 years. And the sponsor will expect to have full control of the enterprise. However, most sports leagues are arranged such that there must be a single “controlling owner” who makes all the decisions for the team, including when to sell it. In the US major sports leagues, to the extent that private equity funds can be owners, they cannot be controlling owners and they don’t have final decision-making power on how and when to make a return on their investment. If the private equity investor is not the controlling owner, it cannot determine when to sell the team, and therefore the private equity fund does not have control over the time horizon to realize an ROI. Private equity funds engaging in such investments have changed their back-end private ordering such that capital within the fund can be deployed without a time horizon for returning that capital to their LPs. To accommodate this dynamic, funds have modified their traditional LP agreements to allow their LPs to sell their interest in the fund (with certain guidelines and guardrails). In other words, LPs are allowed to come and go within the partnership more easily and thereby realize an ROI on their own time frame and outside of a sale of an investment made by the fund itself.
Most leagues also have conflict-of-interest rules that restrict an owner, private equity, or otherwise from owning equity in more than one team. However, some leagues have relaxed these rules to invite more private investment. For example, at one time, with few exceptions, an owner could not hold an equity interest in more than one MLB team. Now, if an owner is an investment vehicle, it can hold equity in multiple teams as long as the ownership interest in each team is less than 15% and is a passive, noncontrolling interest. There are similar rules that allow individuals to be limited partners in multiple partnerships, each one of which can own an interest in an MLB team. There are many other rules that affect private equity owners across the other leagues. Such limitations could be frowned upon by potential private equity owners who may be trying to build a platform that holds ownership across diverse leagues and teams.
Despite these unique features that tend to clash with traditional private equity norms, major sports teams continue to attract private equity investors.