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It’s very common, at one time or another, for the average sports fan to feel like he can run his favorite team better than the club’s owner or manager. What happens though when many such fans, who spend their hard-earned money on admission to games, apparel, and pay-per-view, feel that their voices are being ignored? The answer has historically been relatively little, other than reduced ticket sales and ancillary revenue from a disaffected fan base, which in some circumstances could lead to the franchise moving to a city with a wealthy buyer.
There are obviously significant hurdles involved in starting a professional sports franchise such as acceptance requirements into the league, suitable marketplace for the team, existing infrastructure, but the biggest one is, of course, money. Except in rare circumstances, for one fan or a small group of disaffected fans endeavoring to do so would be cost-prohibitive. Many industries other than sports, including film and television, have been able to move towards the collective will by harnessing the power of the Internet. Could the various portals that sprout every day to service this need be leveraged by a large group of average fans to start or impact their own team? If so, what kind of impact would it have on fan loyalty, engagement, and revenue?
This article will outline the current legal structures that allow forms of crowdfunding and how sports fans could take advantage of these rules and start putting their money where their opinions are.
On April 5, 2012, President Obama signed into law the Jumpstart Our Business Startups (JOBS) Act. The legislation aims to make it easier for start-up companies and emerging businesses to raise and have access to capital. One significant aspect of the JOBS Act is providing a framework for startup businesses to raise money from non-accredited investors through “crowdfunding” by soliciting small amounts of money from the general public through the Internet.
Securities cannot be offered for sale to the general public under the crowdfunding provisions of the JOBS Act until the Securities and Exchange Commission (SEC) finalizes its rules for the law’s implementation. Proposed rules, released in early 2013, have created concern among interested parties that the projected costs associated with compliance for portals and issuers will make this financing under this law cost-prohibitive.
While entrepreneurs wait for the specifics for crowdfunding, two SEC No-Action letters issued in March 2013 gave some guidance on how the Internet could be used to raise funds. Essentially, the SEC stated that two similar companies, FundersClub and AngelsList, do not act as broker-dealers for purposes of Section 15(b) of the Securities and Exchange Act and can earn incentive compensation on “carried interest.” The companies form subsidiaries (each an “investment vehicle”) that conduct due diligence on potential start-up companies that request their help. Once the investment vehicle vets the legitimacy and viability of the start-up, the investment vehicle then gives accredited investors—investors with an annual income of $200,000 or more, or a net worth of $1,000,000 or more—the opportunity to invest in the investment vehicle but not own shares of the start-up company.
Although it is certainly conceivable that AngelsList and FundersClub could be used to solicit funds for a pro sports team by seeking only accredited investors, the pool of investors is limited and sports have always been a passion play rather than an investment. Only wealthy sports fans could pursue their wish to own a team; and in reality, pro sports teams are already owned by this class of investors. The utopian goal is for average sports fans, who individually may already have the knowledge base to run a sports team, to form a financially sound ownership group. Currently, non-accredited investors may not take advantage of the JOBS Act. However, there are some professional teams in the U.S. that are owned by the “fans” through non-profits, municipalities, and foundations set up mostly on occasions when there was a threat that the pro team would relocate.
The Green Bay Packers are the lone franchise of the four major professional sports in the United States owned by its fans. The Packers’ articles of incorporation, first filed in 1923, are based on a now-defunct Wisconsin nonprofit tax law. The team’s ownership structure is grandfathered into the constitution of the National Football League (NFL). Article V, Section 4 of the NFL constitution states that “charitable organizations and/or corporations not organized for profit and not now a member of the league may not hold membership in the National Football League.”
In general, shareholders of the Green Bay Packers are entitled to no profits or dividends and cannot sell, assign, or transfer a share to a third party. Further, no shareholder can own an amount of stock that could cause ownership control issues. Owning a share entitles you to show up once a year to approve a slate of directors. These directors, totaling 45 directors, will then select an executive committee of 7 members, who ultimately make all decisions in managing and operating the Green Bay Packers.
Given the current valuations of pro sports franchises in football, baseball, basketball, and hockey, even if the leagues approved the Green Bay Packers ownership model for other franchises (which the MLB and NFL explicitly prohibit), it would be extremely challenging to raise millions of dollars without giving such investors common stock rights such as dividends and resale rights for a team that lacks such a loyal, established fan base.
Several minor league franchises are community or fan owned, primarily using one of three ownership models. These are: (1) a for-profit model which creates the possibility of giving stock ownership to the community while allowing for common stock rights of a for-profit company (e.g., Syracuse Chiefs and Rochester Red Wings); (2) a pro sports team as a centerpiece of a non-profit corporation used to promote the community (e.g., Memphis Redbirds, Wisconsin Timber Rattlers, and Toledo Mud Hens); and (3) a government entity, such as a county or municipality acquires a franchise, technically making local taxpayers the owners (e.g., Harrisburg Senators and Columbus Clippers). The latter two models may be difficult to replicate in the current economic climate where public subsidies for professional teams and arenas are unpopular.
Intrastate Securities Exemption
SEC Rule 147 provides a “safe harbor” for intrastate offerings (where securities are sold by a company to investors in its home state only). The rule was issued under Section 3(a)(11) of the Securities Act of 1933, which allows for an exemption from securities registration if the “. . . security which is a part of an issue offered and sold only to persons resident within a single State or Territory, where the issuer of such security is a person resident and doing business within, or if a corporation incorporated by and doing business within, such State or Territory.”
Through the time of this writing, eight states have established a legal framework for “intrastate” crowdfunding. These are Georgia, Kansas, Michigan, Alabama, Maine and Washington (where each state’s regulatory authority must create rules for implementation before the law becomes effective), Wisconsin (expected to become effective June 1st), and Indiana (effective on July 1st). There seems to be momentum in this area among state lawmakers as Washington’s intrastate investment crowdfunding bill was signed into law at the end of March, while Alabama and Indiana’s bills were just signed into law this month. North Carolina and some other states are also likely to follow suit. Like the JOBS Act, each of these states provides for a cap on the total amount that can be raised by the issuer under such exemption over a twelve month period.
It is conceivable that a fan base within a state, either having a desire to start a new pro sports franchise or cater to a base in need of professional sports, could start a team with an operating budget of $1,000,000 (which is the most common intrastate equity crowdfunding cap). After the first twelve months, more investors could be brought in to raise another $1,000,000 for subsequent years. More probable, however, is the use of crowdfunding for just a portion of the required funding.
What to Expect from a Crowdfunded Sports Franchise
Crowdfunding for a sports franchise holds more appeal than just the money. After all, creating governance procedures to accommodate a large number of small investors is likely to be a challenge compared to other means of financing. What seems most promising about crowdfunding at least a portion of a sports franchise is the opportunity to increase fan engagement.
It is natural to expect that fans who have an ownership stake will feel an even greater bond with a team than they otherwise would. They will likely be more engaged in the team’s activities, attend more games, feel a greater stake in game outcomes, and make purchasing decisions that will positively impact the team’s bottom line.
Any franchise that considers crowdfunding will want to carefully consider the degree of control granted to fan-owners. There is precedent for crowdsourcing team decisions. MyFootballClub is a U.K. entity whose international membership fees were used to purchase a controlling stake in Ebbsfleet United, a professional soccer franchise. Members had the power to vote on matters like starting lineups, but ultimately voted to transfer this responsibility to the team’s manager. Eventually, declining membership and financial losses caused MyFootballClub to sell its interest in Ebbsfleet United. In the United States, a group led by Fox Sports soccer announcers Warren Barton and Eric Wynalda is seeking to turn the San Diego Flash franchise into the country’s first “publicly traded” soccer club. The club, currently playing in the National Premier Soccer League, is in its first phase of soliciting owners and has aspirations of becoming a Major League Soccer franchise.
While the MyFootballClub experience demonstrates the importance of keeping fans engaged, it should be noted that the majority of the members were foreign. With respect to the San Diego Flash, California’s lack of an intrastate securities exemption provides a hurdle in getting average fans, who may not be accredited investors, involved in financing the team. Fans crowdfunding under an intrastate exemption could be expected to interact and stay involved with a local franchise whose presence in their community is more pervasive.
–Ronald L. Barabas & Michael K. Wheeler
About the Authors
Ronald L. Barabas, Esq. is Counsel at MJ Patel Law Group in Atlanta, Georgia. His practice is focused on corporate and entertainment law.
Michael K. Wheeler, Esq. is Counsel at di Santo Bruno LLP in New York, New York and is the founder of his own sports agency, MAE Agency LLC. His law practice is focused on corporate securities and sports and entertainment law.
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