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Keeping the deal sweet | Why the sports sector needs strong governance and forensic due diligence in dealing with investors

Luca Ferrari, partner and global head of sports, Withersworldwide

The $2.475bn (€2.093bn) acquisition of the MLB’s New York Mets by hedge fund billionaire Steven Cohen, the continuing interest of Private Equity firms in sports properties including Italy’s Serie A football league, and the $1.5bn Initial Public Offering (IPO) of data company Genius Sports through a Special Purpose Acquisition company (SPAC), combine to suggest that, despite the impact of Covid-19, sport remains an attractive proposition for investors.

But while the majority of sports acquisitions and investments may deliver the win-win which is the aim of every good deal, a number of high profile cases show that, after the initial euphoria subsides, deals can and do go bad.

In the English Football League, the acquisition of Wigan Athletic by Hong Kong-based Au Yeung and its near immediate entry into receivership, and the financial collapse and the ultimate liquidation of Bury FC and Macclesfield Town are among the most recent, but they are not alone.

Sports businesses, whether clubs, leagues, agencies, or service providers, are attractive for a range of reasons. But while most investment decisions are taken for sound commercial reasons, some sports properties, notably football clubs, have been seen as ‘trophy assets’ acquired by investors less committed or able to sustain them.

These failures give rise to fundamental questions about the way that potential investors are screened, levels of due diligence on both sides of the deal and the governance framework within which they are conducted.

Kevin McCullagh put some of the key questions to Luca Ferrari, partner and global head of sports at law firm Withersworldwide.

What are the main reasons investments in sport go wrong? Are there structural weaknesses in the sports industry that leave it exposed?

When it comes to clubs, one thing that comes to mind is the difference between sports in the US and in the rest of the world. The US has single-entity model, where the league owns the business and owners of clubs buy into a centralised, usually well-managed championship. The American system, unlike the pyramidal European system, does not involve relegation and promotion, and having been historically granted exemption from the antitrust legislation – the NBA, NFL and other US professional sports leagues are legally defined as a single entity rather than a group of independent companies – they can impose salary caps and drafting rules, which reduce competition between clubs and likewise the risk of bidding wars leading to overspending on salaries and transfers.

Investors in European football face a much higher risk. They cannot impose salary caps and have no equivalent of the NCAA college system or the draft, which means they have to bear the cost of developing and competing for talent themselves. Most importantly, with the exception of a few powerhouses, European football clubs are always at risk of relegation, which, despite some financial protection from leagues, means a near disastrous hit to revenues. Therefore, deep pockets, resilience, and quick learning are the keys to mastering an investment in European football.

Investing in agencies presents different issues because these are relationship businesses. Sports marketing agencies are built largely on a network of personal interaction. A new investment may introduce new finance and marketing skills and other business synergies but success ultimately rests on people, their skills and reputation. One should not underestimate the ‘human factor’ and the empathy needed to run these kinds of businesses.

Talent management agencies are even more deeply rooted in highly personal relationships. No matter how much better advice may be, as a result of investment, or how much wider the range of services becomes, client retention will depend heavily on the loyalty of the agent(s) whose portfolio has been acquired. It is easier to buy a stable of talent than to retain and develop them after the individuals who built it have cashed in. So a key piece of advice is to make a thorough assessment of the human factor and, ideally, to invest into an agency where the founders maintain a significant earn-out interest as well as a reputational stake.

More generally, buying into a sports property, especially a football club, is definitely not the typical private equity investment. It is rather one that will need a dose of personal involvement, the ability to build an emotional connection with the history, place and people that are part of the club’s identity. But here comes the hardest challenge: the owner must be and feel like a fan, but act as a businessman. If you are not able to keep a cold mind and draw on a dose of optimism the day after you’ve lost a crucial game or when the table position starts looking ominous, you should not put you money in this sport.

Asian investment in European football has been particularly problematic, as evidenced by the Wigan Athletic case, Bellagraph Nova Group’s attempt to buy Newcastle United, and the failure of LD Sports’ involvement with Southampton. Are there dynamics at play that make Asian investments into European sports especially risky?

Yes, and I think it may be a cultural issue and a matter of expectations. Of course, it depends on where the Asian investor is from. For example, I am not sure, bar exceptions, Chinese investors understand the sentimental bond that underpins a Club’s competitive and commercial value. Grasping that factor is key to creating the kind of chemistry that enables and empowers the society a club depends on, from fans to local authorities, from vendors to sponsors, from the warehouseman to the top management. And of course, it needs a lot of patience, planning and consistency to develop a steady and lucrative trade, be it in players, sponsorships, or media rights.

Investor interest in sport has ticked up during the Covid-19 period, as sports properties have struggled for cash and investors have sensed bargains. What should any sports property that is being approached by a would-be investor or is seeking investment be doing to make sure that their future investment partners are right for them?

That depends on individual situations. If the property is looking for someone to relieve them of an unsustainable (financial) burden I doubt they will be too choosy. If they are looking for a partner to continue building the club’s fortunes they should be frank about how difficult it is to make money from a sports property, make sure there is a shared, long-term plan and commitment, be honest about weaknesses in management, and open to hand over the reins as and where needed.

Who can and should take charge of managing and regulating investments into sports properties and at what level must this be addressed?

Given that clubs operate in an international marketplace, there should be an international set of rules, ensuring only clean money is invested by reputable investors. The ultimate beneficial owner and origin of funds should always be disclosed and scrutinised. Probably the best way to accomplish this on an equal, international level, is for the international sports governing body to set the rules, impose them on national governing bodies and task them with their application while maintaining the power to intervene where enforcement fails or doesn’t meet set standards.

I have always been sceptical about the utility, effectiveness and, ultimately, the legality of more dirigiste-interventionist rules like Uefa’s Financial Fair Play. While I believe FFP is necessary and effective in ensuring fulfilment of financial obligations across European football, the break-even rule should be revised beyond the changes made in the wake of the pandemic, to allow larger deficits, provided they are fully backed by adequate security and owners’ refinancing obligations. This would give a chance to clubs from less wealthy national markets to reduce the gap with the European powerhouses.

What controls and regulations exist to govern investments in sports properties and do they adequately protect sports properties and investors? If not, what do you think needs to change?

In principle, the EPL ‘Owners and Directors Test’ goes in the right direction and is probably the most stringent test in football. But I have some reservations. The test could be more transparent, and the requirements should be set out more clearly. If you leave too much space for discretion, there is room for political rather than legal criteria to set in. We are all aware of the face-washing and diplomatic motives of some government-led investments in sports. But you either prohibit, for example, direct or indirect football club ownership by sovereign funds, or football must leave it to politics and international law and diplomacy to judge and impose embargoes.

Do you think there should be a global regulatory framework that governs football club ownership, or other types of sports industry investment? And who should – or could – govern this?

It is probably difficult to set global standards, but not impossible to act at regional level, comprising the relevant competitive market, like Europe in the case of football. Such regulatory framework could be promoted by Uefa, but it would need eventually to be freely adopted and adapted by the single leagues to reduce – if not entirely avoid – the risk of antitrust claims.

Third-party investment funds can conceal the identities of the ultimate beneficial owners. Should this be allowed in football club ownership, or other sports investments?

Football club ownerships need to be fully transparent, in my view. The need to ensure genuine and fair competition between clubs is a fundamental obligation towards the fans and ensures the sport’s credibility.

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