While the attention of collegiate sports is focused on the transfer portal and the pending House settlement, a decision by the University of Kentucky’s (“Kentucky”) board of trustees will likely have material and cascading consequences to the industry.
On Friday, Kentucky’s Trustees approved the establishment of Champions Blue LLC (“Champions Blue”), an affiliate, to house the University’s athletic department activities. Part of the stated reasons were governance, compensation, and revenue generation, but based on my experience in sports and private equity, and reading the President’s pitch to trustees, I believe the primary goal is to be the first athletic department to receive private capital.
I also believe that other institutions will soon follow a similar model, which has obvious benefits but also potential potholes.
Focus On The Money
At Kentucky, it will be up to President Eli Capilouto to decide which intercollegiate assets and functions are transferred to Champions Blue. The entity will be wholly owned by another UK affiliate, Beyond Blue Corporation, raising questions on regulatory compliance and tax status. I’ll leave that to the sports law experts in the media.
Instead, I’ll focus on the financial aspects, which I think are significant; while Clemson University spun its revenue generation activities into a separate entity, and the Big 12 conference and Florida State University held exploratory talks, no institution has taken private capital into its athletic department – yet.
The University’s Pitch To Trustees
In its report to trustees, Capilouto’s office emphasized incentives like governance, differentiated benefits and revenue generation. Clemson University touted the latter when it launched Clemson Ventures LLC last August.
But as the report also outlined, Champions Blue will allow Kentucky athletics to “Restructure to accept new capital and approach permanent financial stability”. To be clear, that means direct investment from private capital firms right into athletic departments.
The Benefits Of Taking Private Capital
Private Capital has infinite potential structures, but essentially two categories: equity, where firm-sponsored funds take a stake in a business, and debt, where they lend money with the promise of future returns. Either option provides capital to support costs and fuel growth during periods of transformation, so it’s easy to see the appeal for institutions like Kentucky given the current collegiate sports atmosphere.
The pending settlement between the House and the NCAA would allow schools to share portions of their revenue with athletes, estimated to reach almost $30m per year for a school like Kentucky. The NCAA would also be responsible for back pay to recent athletes of almost $2.8b, which will come from insurance, reserves and tournament distributions that schools like Kentucky regularly receive. Coach salaries (and buyouts), stadium renovations and training facilities are other examples of growing cash outlays outside of the settlement.
Investing in those areas are table stakes for an institution like Kentucky that wants to compete in athletics, and that money needs to come from somewhere. Enter Private Capital.
An Evolutionary Way To Fund A Growing Athletic Department
These firms also provide business expertise and institutional governance, atypical for not-for-profit institutions. How does Kentucky allocate resources intelligently, recruit talented student-athletes, position their teams for sustained success, all while ensuring positive returns to the university that drives their mission? That’s an issue Florida State likely wrestled with when they explored private equity last year. Their Athletic Director Mike Alford called it “the future” of collegiate sports.
But Would Private Capital Even Be Interested?
It’s a fair question. In fact, some Private Equity leaders were lukewarm to the idea when surveyed earlier this year. And Ian Charles, who I respect greatly as a pioneer and titan in sports private equity, highlighted that media rights are negotiated at the conference level, and an unstable landscape, as reasons that his firm, Arctos, wouldn’t be comfortable. To Charles’ point, just last week, Judge Claudia Wilken withheld her approval of the House v NCAA settlement because of concerns over roster size restrictions, and the deal is now in jeopardy.
But Champions Blue was created under the presumption of a “new era” of “directly compensating student-athletes”. Whether it happens via this settlement or further litigation, the overwhelming presumption is that it will happen. So while the landscape is currently murky, the most beautiful lotus blooms from muddy waters (I love that quote).
Appetite Will Be Immense For Three Main Reasons
First, while the collegiate sports regulatory landscape isn’t predictable, the revenue streams certainly are, and that’s ambrosia for PE. That’s thanks to locked in media rights deals that count in the billions, and a very loyal customer base. Professional sports are an appealing asset class because customers are sticky for their entire lives. But according to market research, collegiate sports fans are even more loyal, and the most loyal of all, are fans in the Southeastern Conference (SEC). Kentucky plays in the SEC.
Second, private capital firms are skilled at surfacing value from undervalued assets. It’s confusing that the National Basketball Association (“NBA”) earns twice as much revenue as college football, with half the viewership. Other industry experts have pegged the gulf as wide as 5 to 10 times. All this despite collegiate brands, such as the Universities of Notre Dame, Southern California, Michigan and Texas, that rival professional sports.
And third, an unprecedented level of private equity firms have recently raised sports-centric funds. That’s led to an unprecedented level of deals (disclosure: this data is via my firm The Ledge Company).
Professional sports is a scarce resource/trophy asset, part of the reason teams are so valuable. These firms need to put their money somewhere. Now, the typical fund life ranges from 6 to 10 years, so some of those investments may hit the market again. But the market is saturated, and the LLC model that Kentucky is pursuing opens a gateway into a brand new frontier for investment.
Implications If Institutions Pursue Private Capital
First, historically universities have wholly owned their athletic teams. An affiliate structure, complete with outside investors and a profit-seeking focus, is a seismic shift, outside their core capabilities. Perhaps relatedly, Clemson Ventures recently hired Michael Drake, a “longtime NBA and NFL executive”, as their CEO.
Second, accepting private capital means accepting new expectations and priorities, such as growth and return targets. Yes, in certain aspects, the interests of private capital and the University align, such as on revenue generation; both entities will want to maximize the value they drive from collegiate athletics, to retain the best student-athletes and ensure sustained success. But many athletic departments don’t make a profit, so what happens if cutting certain sports will improve the bottom line? Yes, private capital can be passive, but typically that’s dictated by target-side leverage, as it was with the NFL. Not every collegiate institution has that weight.
Foreign Sources Of Funds Are Restricted
Third, identifying the source of the sponsoring firm’s funds, including their limited partners, can be complicated. Universities have robust processes to vet donations for regulatory compliance. For example, Section 117 of the Higher Education Act of 1965 requires semi-annual disclosures of foreign contributions that exceed $250,000 (there is proposed legislation to lower that to $50,000, and $0 from certain “countries of concern”). How does that factor in? And who is guiding these new entities on flagging foreign funds? Yes, these are affiliates, but they, like Champions Blue, fall ultimately under the umbrella of the university. A matter for the legal experts as well.
Fourth, do athletic departments and institutions at-large have the inherent pace and capability to evaluate a large potential investment?
Not to belabor the point, but these are green field transactions. Institutions will have evaluated similar firms in the past for managing endowments, likely know advisors they trust, and have executives and trustees that have relatable experience. But an institutional process – a road map, often relied on for transactions – is unlikely to exist.
And finally, the impact of all this on Title IX, the regulation that requires gender equitable spending from institutions that receive federal funding. Another consideration for lawyers, though some have already suggested the proposed settlement itself violates Title IX.
Expect This To Happen Quickly
If and when the house settlement is approved, it’s expected to go into effect later this year. “Gold rush” has the word “rush” for a reason, and it just takes one match to light the fuse. To wit, when discussing the possibility earlier this year, Michael LaSalle, a partner at Shamrock Capital, presciently said “You have to find somebody willing to be a trailblazer”.
I think that trailblazer is Kentucky.
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