On this episode of the R&G Dugout podcast, Ropes & Gray asset management partners Amanda Persaud, Lindsey Goldstein, and Jon Rash explore the upsurge of private funds raising capital for investment in sports teams and businesses. They discuss the various structures of sports funds, the challenges of valuing sports assets, and the unique considerations for investing in U.S. sports leagues and teams. Tune in to understand how private capital is navigating this dynamic industry and the innovative fund structures emerging in response.
Transcript:
Amanda Persaud: Welcome back to the R&G Dugout, a podcast series brought to you by Ropes & Gray, focused on analyzing the landscape of sports, entertainment, and media investments. On today’s episode, titled “Show Me the Money,” we examine how private funds are becoming an increasingly common way of aggregating private capital to invest in sports businesses.
Before we dive in, I’m Amanda Persaud, a partner in the asset management group.
Lindsey Goldstein: I’m Lindsey Goldstein, also a partner in our asset management group and based in New York.
Jon Rash: And I’m Jon Rash, also a partner in the asset management group, based in D.C.
Amanda Persaud: In our prior podcast, we discussed various disruptions to the sports industry, including changes to major U.S. sports leagues’ rules governing team ownership as well as the developing changes in college athletics to allow athletes to be compensated for their name, image, and likeness, also known as “NIL.” All of these changes are creating new opportunities for private capital to invest in an industry that, by some accounts, stands at more than $2 trillion. And while investing in U.S. teams is a newer part of the industry, it’s fair to say we’ve seen our clients investing more broadly in sports and sports-adjacent businesses for many years—they’ve been doing that through family offices and traditional private equity [“PE”] funds. What’s increasingly of interest, however, to industry participants, are funds that are specifically targeted to sports investments.
Sports funds seek to provide investors with indirect exposure to a variety of sports-related investments that fit within a particular fund’s return profile. For instance, while an ownership interest in a professional sports team might be the crown jewel of a sports fund, these types of investments are highly illiquid, and they call for longer hold periods—they also call for unique fund terms. Compare that to investments in sports service providers, sports tech apps, or lending to sports enterprises—all of which are more liquid investments than a sports team ownership: they tend to be suitable for hold periods and terms that one might find in a private equity fund or a credit fund.
Before we get into the details on fund terms, Lindsey, could you level set for us what’s commonly seen in the market today?
Lindsey Goldstein: Of course. Without limiting ourselves to sports-focused funds for a moment, private funds may utilize a variety of structures, including an open-end or hedge fund-structure, a closed-end or PE-style structure, or an evergreen or “hybrid” structure that combines certain elements of the traditional open-end and closed-end funds. Of course, funds of each of these structures will vary from one another, greatly depending on their terms and how those terms are applied. There will be numerous, and varying, considerations when determining the optimal structure for a sports fund—those include, but aren’t limited to, valuation of fund assets and how fees will be calculated, the expected term of an investment in the fund, and what liquidity options will exist for investors.
Jon Rash: Picking up on the valuation point, which is critical to figuring out the right structure, a sports fund can hold interests in professional sports teams, interests in professional sports venues, interests in vendors that service sports teams and their fans, royalty-stream participations, and debt instruments issued by entities that control or own any of those assets. All of these assets have varying degrees of valuation difficulties, given that they generally do not trade in typical markets. The fact that sports assets are thinly traded, usually—and therefore, hard to value—is one reason why many sports-focused private funds use closed-end PE-style structures that limit investor withdrawals. However, certain investors in this space desire more liquidity than the traditional closed-end fund structure can offer, so we expect evergreen sports funds with hybrid liquidity terms to continue gaining traction. And structure impacts other key terms—for example, what types of fees the manager will charge.
Amanda Persaud: That’s right, Jon, and the fee point is actually an important consideration both for sponsors and for the investors as they decide on fund structure. Take, for example, open-end funds—they’re more likely to charge an asset-based management fee equal to a percentage of the fund’s net asset value (“NAV”) and an annual performance-based fee or allocation equal to a percentage of new capital appreciation. Both of these fee constructs assume that the fund’s net asset value will be calculated accurately with some regularity—for example, each quarter or maybe semi-annually. In contrast, for funds that expect to invest in highly illiquid, hard-to-value assets, charging management fees on the fund’s NAV may be impractical. Instead, it could be more appropriate to charge management fees on the aggregate cost basis of the fund’s investment after making adjustments for write-downs and write-offs.
Jon Rash: And fees are going to be tied to valuation issues as well. Funds that will hold equity interests in sports teams or sports-related real estate, for example, will generally have difficulty valuing those investments on a regular basis and may opt to charge management fees on invested capital and incentive fees on realized profits as a result. A fund that holds public equity or traded debt of sports-related issuers may find regular valuation of fund assets to be feasible and choose to charge management fees on NAV and incentive fees on mark-to-market gains. For sports funds that hold significant positions in both liquid and illiquid assets, which is not uncommon, the sponsor will have to make careful decisions about fees and other terms in dialogue with counsel and key investors.
Lindsey Goldstein: You may be noticing that valuation is a recurring theme for sports funds—it drives structure and other key terms like fees, as Jon noted. Focusing on open-end funds for a moment, in addition to fees, valuation impacts how investors subscribe for interests. A new investor in an open-end fund will effectively buy into the fund and hold a percentage of the equity based on the size of its contribution relative to the fund’s net asset value. The new investor won’t want to buy into the existing assets that are overvalued, and existing investors won’t want to have their interests in the existing assets diluted at less than fair market value. Valuation also impacts liquidity rights in these funds. An open-end fund might utilize side pockets or slow-pay mechanisms to accommodate illiquid investments, which are inherently harder to value than the traditional open-end fund investments subject to monthly or quarterly valuations. Investors will have limited withdrawal rights and perhaps different fee terms with respect to the side-pocketed investments.
Amanda Persaud: In contrast, private equity and other types of closed-end funds, which have developed over time to facilitate pooled investments in hard-to-value assets, may help solve some of the limitations of an open-end structure. To address the concerns Lindsey noted earlier for open-end funds, a closed-end fund will typically only accept investments for a limited period of time. All investors will participate in all fund assets pro rata based on their capital commitments to the fund—fund assets are generally not revalued prior to each admission date. This approach is based on the assumption that fund assets should not materially change in value during the offering period.
Sponsors might also consider so-called “evergreen” structures or longer-term structures, which offer a kind of hybrid model for investors who are not completely satisfied with either open- or closed-end structures—we’ll talk more about these shortly.
Lindsey Goldstein: Given the wide-ranging illiquid profile of sports investments, sports funds that wish to invest more broadly in assets regardless of liquidity features are likely to find that identifying the optimal way to address investor liquidity needs, while not impeding the fund’s ability to make illiquid investments, requires careful consideration. Funds that expect to hold illiquid assets, such as ownership interests in teams or leagues, may be unable to generate cash to pay out any withdrawal requests. In addition, sales or other transfers of a direct or indirect team investment will often require the relevant team’s and league’s consent. This approval process is often lengthy, and consent is at the league’s discretion. Holding such illiquid investments that will likely never realize without a negotiated sale forces a sports fund sponsor to think carefully about how it will balance that illiquidity with investor expectations of eventually exiting their own investment in the fund.
Jon Rash: As an aside, investors may find liquidity for an otherwise illiquid fund interest through a secondary sale of that fund interest. However, fund sponsors will generally not guarantee this type of liquidity, and a sales price may include a significant haircut from the book value of the fund interest because it itself is illiquid.
Amanda Persaud: As sponsors look to solve the liquidity conundrum presented by any particular sports asset, we anticipate seeing an uptick in interest for evergreen funds.
Some evergreen funds look like open-end funds but impose strict limits on liquidity. For example, an investor might only be permitted to withdraw five percent of their investment per quarter. The intent is that the fund should not have to liquidate large positions at inopportune times. This may provide a fund with more time to sell an investment in a team or to find new investors to cash out existing investors.
Lindsey Goldstein: A second category of evergreen funds are sometimes called “slow-pay” funds. As noted a bit earlier, these handle withdrawal requests by effectively side-pocketing a slice of the fund’s portfolio for each withdrawal request. The slow-pay slice can be subject to the same or different economic terms as the portion of the fund that has not been withdrawn. In this structure, the withdrawal request results in the relevant investor ceasing to participate in new fund investments and receiving distributions once the then-existing investments are realized—which may be over a multi-year period. This can be an attractive structure because it eliminates the contractual pressure a sponsor may face to dispose of team investments.
Stay tuned as we’ll be taking a deeper dive into the world of evergreen funds in a future Ropes & Gray podcast.
Jon Rash: Aside from the liquidity considerations we’ve been talking about, it’s worth pivoting to discuss the unique issues arising for sports funds investing in U.S. leagues or teams. These funds face certain restrictions under league rules which impact the standard terms found in private fund documents—these include borrowing, confidentiality, withdrawal, and investor-initiated fund termination, to name a few. Typical customary private fund terms will frequently need to be modified for a sports-focused fund.
For example, league or team rules may limit how a fund utilizes leverage. Many private funds rely on borrowed cash to enhance returns on investments, to pay expenses, or to limit the frequency of capital calls to investors. Many of these credit facilities will require the fund to pledge some or all of its assets. However, league rules generally do not permit interests in a team to be transferred or encumbered without league consent—this may limit the availability of credit to the fund.
Lindsey Goldstein: Another example relates to confidentiality. Many institutional investors in private funds require assurances around the use or disclosure of their name by the fund and its sponsor. Sponsors of sports funds should be aware that any direct or indirect investor in a professional sports franchise will most likely require the fund to disclose not only the names, but also potentially other information, of its investors.
Further, related to some of the liquidity issues noted earlier, sports funds may have to adopt specialized compulsory withdrawal terms. A sports fund will want to ensure that the sponsor’s right to expel an investor covers situations where required by a team in which it holds interests, or the relevant league itself, or where expulsion is in the best interest of the fund due to team or league rules or policies. A compulsory withdrawal may be necessary where an investor is determined to have other direct or indirect holdings that are prohibited under applicable team or league rules or where an investor would otherwise exceed an indirect ownership threshold triggering additional obligations.
Amanda Persaud: League or team rules may also force a sponsor to implement investment limitations in the fund’s agreement. As Lindsey just touched on, certain leagues may very well have limitations on direct and indirect ownership—for instance, NBA rules. These rules prevent sponsors from investing in businesses in which an NBA player has a material interest.
As a result, avoiding certain prohibited investments means a sports fund will need to be prepared to dispose of any investment if the league determines it creates a conflict of interest, regulatory non-compliance or increases the risk of reputational harm. A sponsor will also want to be cognizant of investment restrictions that may apply on a look-through basis to the fund’s underlying investors, and therefore, consider how to best ensure compliance both under the fund’s agreements and with the league and team rules.
Investors in private funds may very well be accustomed to various rights to terminate the fund’s ability to make investments, to remove or replace a general partner, or even cause a winding-up of the fund. Where a fund holds an interest in a sports team, these rights may need to be limited or modified, as the league or team rules will generally prohibit the fund from engaging in a change of control without the consent of the team or league. In such situations, traditional investor governance rights may need to be modified or eliminated outright. This also means that a forced windup of a sports fund is simply impractical, at least on a timeline to which traditional institutional investors are accustomed.
Jon Rash: Sports funds often have the right to call additional capital from investors at any time during the term of the fund, including after the fund’s investment period. This can be challenging for many institutional investors. However, leagues generally require that each team satisfy certain standards in the operation of the team and its home venues. Team or league rules will frequently require that each team be able to require contributions from its equity holders, which can include sports funds, for the purpose of capital investments or improvements that are necessary to meet the league standards.
Lindsey Goldstein: Finally, certain categories of investors, namely foreign sovereigns, raise additional issues for sports funds. As Amanda mentioned, certain leagues, including the NBA, have rules limiting direct or indirect ownership of its teams by governmental investors. Even where a sovereign investor’s permitted to participate in ownership of professional sports teams, those investors may still complicate a sports fund’s investment. For example, most sovereign investors will assert their sovereign immunity against any claims in their capacity as an indirect owner of a professional team or an investor in a sports fund. Sovereign immunity may be incompatible with the fund’s obligations under league rules or may prevent the fund from receiving undertakings from the sovereign to backstop the fund’s obligations to the relevant team or league.
Amanda Persaud: In conclusion, we anticipate sports-focused funds continuing to gain traction. The illiquid nature of investments in sports teams coupled with unique league regulations will encourage continued innovation in sports fund structures. Some sports assets are better suited to evergreen structures, while other assets such as those in the tech space, product development, real estate, and even credit might be better suited to what we’re accustomed to seeing in private equity and in credit. This is a really exciting time that presents tremendous opportunities for sponsors raising capital that target the sports industry.
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