Universities Explore Private Equity Partnerships as Roster Costs Rise
The House settlement redefined college sports, but though it resolved revenue-sharing and name, image and likeness (NIL) issues, it opened the door to new concerns for schools.
Colleges now find themselves in a competitive bidding environment, paying out enormous amounts of money, which they assert are unsustainable. One proposed solution is to engage with private equity (PE) firms to help fund the arms race.
What Is a PE Transaction?
A PE transaction may be a sale or a joint venture (JV) but fundamentally involves the transfer by a business owner of all or significant interest in a business to an entity controlled by an outside investment group. The business may be relatively small or enormous, as can be the investment group. However, the core principle remains that the existing shareholders or owners of the business transfer all or part of their interest and receive a significant amount of cash but cede some level of control.
On closing, the seller has become wealthy while the business and its customers or stakeholders benefit from a large infusion of capital from PE. This enables the business to expand operations, buy cutting-edge technology, hire top-shelf management expertise, reduce overhead, achieve savings from volume purchasing and similar benefits.
Most of the same principles apply in the case of a JV transaction. On paper, it is a “win-win.”
Whether the deal is an outright purchase or a JV, PE buyers require substantial control to protect their investments. Capital invested by a venture capital (VC) entity also requires that the investor receive an adequate return for an adequate term. How adequate depends on the requirements of the investor.
Another component often present in a JV transaction is how future capital requirements are handled, since the VC deal itself is usually intended as a springboard for additional business growth or market share acquisition. The JV may contemplate that significant capital is required to build or further expand the business, and very often, each partner is responsible for a capital call if that occurs. This can have a significant impact on the operation of the JV project going forward.
How would PE partnerships between investors and colleges work?
Recently, college conferences and individual universities have discussed “partnering” with PE to help fund the compensation wars. A proposed model involves transferring media rights, IP assets and other sources of revenue relating to or arising out of college athletics to a JV, in which the institutions would retain an interest. The JV partner would provide a large upfront payment to the school, and the university would also retain a share of the revenue stream produced by its interest in the JV in the future. If successful, the venture would provide the institutions with cash plus ongoing funding to be able to compete in the current Wild West market of college athletics. Is this a solution, or is it a mirage? Only time will tell.
Any PE arrangement is, first and foremost, a business transaction. Some PE deals are clear steps toward a larger ultimate sale to another buyer. Others may be an investment in developing an enterprise or endeavor where, in addition to capital, the PE brings new or deeper management to the business and expects to make it more efficient and profitable or enable it to roll up still more acquisitions. Thus, one sports or athletic PE transaction could ultimately lead to a relationship with all or part of a conference. Regardless, colleges should distinguish this type of funding from relationships with boosters or donors supporting their alma maters.
What risks are involved with a PE joint venture?
While the PE concept seems simple enough, the college sports space is controlled by universities. Ownership by universities can present serious complications, roadblocks and risks in a transaction.
A state university is generally an instrument or subdivision of the state government where it is located. A state university can have state law restrictions on what government-owned property or activities can be sold, transferred, encumbered or controlled by nongovernment parties, such as a JV partner.
A private university is usually a corporation which has qualified for and been granted 501(c)(3) status by the IRS as an educational institution. Charitable 501(c)(3) entities are limited by strict IRS restrictions on excessive Unrelated Business Income, private inurement and private benefit issues that can endanger their charitable exemptions. A misstep could lose the university its exempt status, potentially subjecting it to income tax and producing other downstream consequences.
For example, both state and private schools probably have facilities financed by tax-exempt bonds. The status of these bonds could also be put at risk, producing far-reaching consequences for the investors and institutions who bought those bonds and the universities who participated in their issuance. These issues will have to be carefully negotiated, structured and meticulously documented in any PE arrangement.
How could schools use venture capital to support their growth?
Several of these entities exist already. Clemson University created an LLC to be involved in several aspects of campus life. Its website indicates that it involves athletics, hosting concerts at university facilities and other activities. It appears the structure contemplates VC investment in that entity, which in theory could extend to other endeavors of the university. The University of Utah appears to have taken a different path and will transfer “commercial operations,” managing stadiums and arenas, branding, licensing and sponsorships, ticketing and other activities to its JV with a private equity group.
Sports marketing company Learfield is finalizing a sale to a VC entity and may have its eyes on even broader involvement. Learfield already handles broadcast rights for a number of major universities, and it also has a division which actively assists them with NIL arrangements. In theory, a conglomerate could result which is involved in all aspects of an athletic department.
Going further, a PE arrangement could be structured with an entity like Live Nation, or as a commercial real estate development operated by the JV on a campus and surrounding property, similar to The Battery at Truist Park where the Atlanta Braves play. Where The Battery contains numerous apartments, the joint venture might replace them with student housing and game-day condos which it manages, and lease space to restaurants, bars and other entertainment venues in the development district. Should site acquisition prove difficult, the university would have the legal authority to acquire property by eminent domain.
Universities are revenue-producing behemoths and include revenues from parking, food service, IP, research and development. They have student bodies the size of small cities which have to be served and supported. It is unclear exactly what aspects of this might be included in a future JV. In theory, many aspects of campus life could be overseen by a JV in addition to athletic licensing, advertising and revenue sharing with athletes. The potential for revenue generation seems limitless.
How could PE ownership affect litigation on issues like player eligibility?
A PE affiliation presents certain appearances of commercialism and professionalism, which might impact the perspective of the courts. For example, even in the Alston decision, which was critical of the business model of the NCAA, the justices seemed sympathetic to and complimentary of the concept of college sports, particularly Justice Kavanaugh in the concurring opinion. The problem was simply that the NCAA model depended on keeping an unpaid workforce.
In a future eligibility case that might affect the character of the college game, a PE or conglomerate structure might create a minor-league or wholly commercial feel, which could affect the view of the courts. All said, if another solution to roster costs cannot be found and an arrangement can be structured to comply with applicable legal requirements, the PE structure might be part of the future of college sports. The true cost, however, is unclear, and involvement may yet lead to further transformation of the traditional college sports concept.
Please contact Tom Sullivan, Rhett Parker or any member of the Phelps sports team with questions or for advice and guidance.
