Disadvantages of Private Equity Investment in Sporting Franchises

In the previous article, we have already seen that private equity firms are making a beeline in order to invest in sporting franchises. This is happening because private equity investments seem to have reached the saturation point in other industries.

The sporting industry is providing an opportunity for high growth. This is the reason why private equity funds have started making investments in sporting franchises across the globe.

The trend has become quite prevalent in Europe as well as the United States. In fact, it has become so routine that private equity funds have even invested in the sporting leagues in developing nations like India.

The initial investments made by private equity firms were met with enthusiasm. However, over the next couple of years, there have been some instances wherein the investments made by private equity have been opposed.

The most famous example is the investment made by a private equity firm in La Liga. CVC Partners has acquired a 10% stake in La Liga for $2.7 billion. However, the sale of this stake was vehemently opposed by Real Madrid which is one of the largest clubs playing in Spanish La Liga. Similarly, the sale of stakes to private equity funds is being closely monitored and scrutinized.

In this article, we will have a closer look at some of the negative points that are commonly associated with private equity funding.

1. Shared Ownership: The current investors who hold a stake in the equity of the sporting franchises often face several issues when it comes to sharing the ownership with a private equity firm. This is because of the fact that private equity firms are known for hard bargaining regardless of whether they own a majority or a minority stake.

   Many franchises have claimed that private equity firms try to gain a disproportionately high influence in the decision-making process. The end result is that the rights of other shareholders end up getting compromised in this shared ownership experience.

2. Corporate Culture: The culture and the way of working for private equity firms is quite different as compared to sporting franchises.

   Sporting franchises rely more on fan experience and are willing to tolerate some periods of low or no profitability in order to maintain the experience. This is not the way private equity firms work. These firms have a highly corporatized culture and every action is looked at from a financial point of view.

   The decision-making process followed as well as the decisions made by private equity firms is very different from the sporting industry in general. As a result, there is always a possibility that a dispute may arise sooner or later.

3. Intention to Sell: Private equity funds are generally formed for a short period of time. This means that investors typically pool their money for a short period of time i.e. three to five years. Hence, private equity funds have a very clear time horizon within which they want to sell the business. As a result, they start taking steps that are only meant to increase the profitability of the franchise in the short run even if it has a negative impact in the long run.

   The short-sighted approach of private equity investors is opposed to the long-term orientation of other investors. This is the reason that investments by private equity funds are opposed. The reason is that many private equity firms have started creating evergreen funds i.e. funds that do not have a specific time horizon in order to invest in such businesses.

4. Debt Funding: Many times, executives at sporting franchises are skeptical of signing equity deals with private equity firms. They believe that private equity firms will end up taking a lion’s share of all the earnings. It is for this reason that many sporting franchises instead opt for debt funds from these private equity firms. They are able to offer funds at a lower rate and at better terms compared to banks.

   However, the problem is that if the franchise is not able to make periodic payments, then the control of the franchise may end up with the private equity firm. There are some critics who have argued that private equity firms intentionally pile on more debt on sporting franchises. This is done with the intention of inducing a default and then taking over the control of the franchise.

5. Lack of Control: Because of several negative tactics used by the private equity funds such as incessant cost cutting, there are many sporting leagues that explicitly state that the control of a sporting franchise cannot be passed on to professional investors such as private equity funds.

   These leagues allow the funds to take ownership and obtain dividends. However, they are categorically against allowing the funds to sit on the managing board and take complete control of the franchise.

6. Relegation and Lockouts: Last but not least, the private equity firm also faces some huge risks.

   For example, there have been instances in the past where teams have not been able to play since the players’ union and the sporting franchise have not been able to reach an agreement regarding the wages that need to be paid. This situation is called a lockout.

   There have also been other situations wherein top-tier teams have been relegated to lower tiers and this has caused tremendous loss to private equity partners which they have not been able to recover.

The fact of the matter is that there are several possible negative outcomes related to private equity investments in professional sports franchises.