The last time out I sang the praises of the MLS single entity structure. But let's talk now about the limitations of that structure.
To start I'd like to clarify what exactly investor-operators own and how they come to own it. I originally said:
. . . MLS contracts with owners to operate the teams it owns. These contractors retain a portion of ticket sales and other revenue, and must pay a portion of operation expenses. Contractors have a right to operate the teams they contract for and can sell a percentage of that right to other investors who may not be investors in MLS LLC.
But that's not the whole story, and I started thinking about the precise arrangement once I read
Kenn Tomasch's response to my post. If you want to know the whole thought process, you can read that and the comments, but it's sort of convoluted. Here, to the best of my knowledge, is how MLS's ownership structure works:
MLS, LLC, the "single entity" has three classes of shares, A, B, and C. If you own class B or C shares, you share in the losses and profits of MLS, but you are not contracted to operate a team, nor do you incur costs or receive a larger share of local revenue like the operator investors do. However, if you buy a class A share, called a unit, you own a percent of MLS LLC, and you also have the right to contract with MLS to operate a team.
To illustrate, an investor puts up a certain amount of money - startup cash for the original owners, expansion fee for the new ones - to obtain that class A unit. This initial money goes to MLS LLC and is part of the balance sheet. As for the A unit, let's assume for simplicity's sake that it’s just a nondivisible share in MLS, equal in size to all other A units, that flexes in percentage as operator investors come and go.
Now, investors can hold that A unit however they want. I suspect most A units are owned through a corporation or LLC. In that instance, investors can then sell various shares in the entity that owns the A unit to other investors while still maintaining control of that entity. This is how you have local investors that own shares in the operation of a team, but do not take part in the overall governance of MLS.
Maybe the entities that own the A units operate the team through yet another entity, maybe not. But whatever entity holds that A unit gets the right to share in the profits and losses of MLS LLC (which owns all the teams, intellectual property, revenues, etc.) in addition to the profits and losses that are the direct result of operating a team in their home territory, in addition to being able to bring on “local” investors in that entity. And if an investor decides to sell their interest in an A Unit, the new owner of that unit will pay the owner, not MLS, for that share of the LLC.
Let's apply it to a ready example. In regards to DC United, William Chang lead a group that paid AEG ca. $33mm for the A unit investment in MLS that gave them the right to operate DC United. Only AEG and anyone else who might have had an interest in that A unit, either directly or via a holding entity, would have taken a cut. Later on, Chang then bought out the other investors who had shares in the entity they used to purchase the A unit, so he became the sole owner of the entity that owned the A unit.
So with that in mind, let's talk about the limitations of single entity. When we talk about the limitations of single entity, we're talking about the ways in which the local operation of teams impacts MLS LLC in a way that might not be expected from a centrally run entity. One such limitation is in regards to stadia. If you have access to lexis, you can take a look at
4 Marq. Sports L. Rev. 551, which discusses how although the overall MLS strategy is for smaller, more intimate venues, even Lamar Hunt made allowances for the presence of larger stadia. The piece is written with an eye toward breaking the single entity anti-trust exemption of MLS, which I think is speculative as a theory at best, but what it does in fact show is how broad the stadium requirement has been in MLS.
What's very interesting is that 1) All the first stadiums built around the turn of the millennium for MLS - Crew Stadium, Home Depot Center, Gilette Stadium - were privately financed, and 2) MLS was fine with New England Revs owner Robert Kraft building Gillette Stadium, because it gave the league access to a venue that could be used to host larger competitions like the World Cup, Gold Cup, Hexagonal and international friendlies. It also allowed the combining of resources with the Patriots to streamline operations. Lamar Hunt, famed builder of Crew Stadium, used the Kraft model in Kansas City when he operated the Wizards (or Wiz, depending on how old school we want to get).
It's worth noting that Kraft's approach has been almost wholly appropriated by Seattle Sounders FC, right down to the artificial turf (which for New England didn't come in until 2006), but with the exception of shaking down taxpayers to build the stadium. Why one team is the toast of MLS despite not winning a playoff game and the other doesn't draw dick despite making the playoffs year in and out is a topic for another post. But the point is that for as much
Bill has very valid issues in regards to "soccer-specific stadium" being a "building you control with default dimensions for soccer," it's clear that from early on, larger buildings were permitted if they were controlled by the owners, there was operational overlap with other tenants, and the building could be used to
generate revenue from other competitions.
Another limitation of the MLS single entity structure is on revenue.
In Fraser, the appeals court stated:In return for the services of the operator/investors, MLS pays each of them a "management fee" that corresponds (in large part) to the performance of their respective team. The management fee equals the sum of one-half of local ticket receipts and concessions; the first $1,125,000 of local broadcast revenues, increasing annually by a percentage rate, plus a 30% share (declining to 10% by 2006) of any amount above the base amount; all revenues from overseas tours; a share of one-half the net revenues from the MLS Championship Game and a share of revenues from other exhibition games.
Keep in mind that the teams were not responsible for salaries of league personnel, player salaries and benefits, game related travel expenses, half the stadium lease, and other costs. So in theory a profit can be turned from operating a team, aside from what the owner investor receives from MLS LLC itself. At a symposium discussion memorialized at
12 Fordham Intell. Prop. Media & Ent. L.J. 413 attorney Jeffrey Kessler compared this to the revenue sharing arrangement in the NFL. He also characterized it very much as a hybrid arrangement:
No sports entrepreneur really wants to invest in such a [pure single entity] league, so an internal struggle develops among the Major League Soccer entrepreneurs. "Do we really have to give up all this control? Can't we operate our teams separately? Can't we have separate franchise values? Do we really have to share all of our profits?" And a compromise is reached that keeps shifting, and that is what the record facts in the Fraser case show.
The context of the statement is Kessler arguing that MLS in not in fact a single entity, which I won't touch on but I think his point on the revenue is very much illustrated by the most tangible evidence of a breakdown in single-entity: the designated player. The designated player rule essentially says that the various investor-operators can use their own funds to finance one or two marquee players outside the salary cap, with of course the caveat that doing so will
deal a potentially crippling blow to your salary structure.
On its face it seems to indicate a level of profitability in the MLS arrangement, and in particular at the local operator level. The theory being that if a team can turn a profit locally, then it can reinvest that money in one or two high caliber players. Or what seems to be a more frequent occurrence, teams can gamble that spending more on players will allow the team to be successful on the field, and in turn, profitable.
However, Soccer United Marketing, a shared investment among the owners, obviously plays a huge role in how profitable the league is, and if the main money to be made is at the local level, then what incentive is there for non-operator investors to have a stake in the league? And in order to finance Beckham, the LA Galaxy, one of the best supported clubs in one of the largest markets, in a jewel of a soccer specific stadium, with the deepest pocketed owners, played a lot of overseas friendliess, which if you'll note, are competitions AEG were allowed to keep all the revenues from.
Nevertheless, it's here, at this point, where people like BA Duane start their attack on single entity: if our team is flush with local money, then it should be allowed to leverage that money by reinvesting it in new players. Likewise, teams that don't have this local money shouldn't be allowed to compete at the same level because it holds back the teams with more revenues.
It's precisely this type of arrangement that single entity was designed to thwart, for the very concrete reason that higher revenue teams spent the NASL to its death back in the 80's. A league is only as viable as its weakest teams, and if the league does not look after those teams, then it runs the very real risk of becoming uninteresting to the point of having a to implement a
plinko-
esque playoff system (with apologies
to Mgoblog for ripping off that analogy) to
relieve the boredom.
On the other hand, I suppose you could make the argument that MLS is already there in regards to the playoff plinko. Besides, in pro soccer, that's really the best case scenario. The worst case is death, and the threat has been very real until *maybe* the last three or four years.
Anyway, in the piece that got me thinking about all this, Steve Davis does an excellent analysis about the very debatable impact of the designated player, and posits that changes to the rule would be more in line with
getting teams to take a chance on a designated player as opposed to adding more slots:
So, for instance, if the salary-cap impact is reduced to $200,000 per DP, owners might be more willing to take the plunge. In that scenario, the percentage of salary cap tied up in a club's first DP is theoretically lowered from about 18 percent to less than 9 percent.
Again, those numbers stand to be adjusted by the multilayered, ongoing CBA negotiations.
He then wondered aloud what the
impact on the league parity band if the designated player restrictions were loosened:
The well-bankrolled L.A. Galaxys and Red Bull New Yorks, etc., can afford the lavish salaries that DPs will command. Sources tell me ownership in L.A., Seattle, New York and D.C. United are driving the charge to add a second DP asset per club.
The bullish big spenders can afford to take the risk, paying grande on the front end and betting that they’ll spin gold on the back end. Meanwhile, the smaller and the spendthrift will be left to purchase economically.
Personally, I find it outrageous that DC United is pushing for a second DP slot when
they aren't profitable and won't be until they get at minimum an-as-of-now non-existant new stadium. And as Davis points out, it's really hard to show a positive impact on the bottom line in DP instances other than Beckham (although without Schelotto, the Crew don't win MLS Cup 2008 or two straight Supporters Shields).
The designated player rule represents the biggest challenge to single entity, but it's also wholly dependent upon the single entity structure for its existence. If the league itself determines that expanding the rule is for the good of the league, it will expand it. If the league as a whole starts bleeding too much cash because of it, or ownership groups start to totter, the rule will be reigned back in. I'd like to think the parity argument plays some role here, but I think the main consideration really is economics. As it currently stands, the rule was a limited experiment. Now that we've seen some of the impact of it, how can the league as a whole tweak it to improve the standard of play without totally trashing its parity model? Despite what others want to see, I think that's the extent of the discussion.
A league in total control of itself as a collective interest is maybe the biggest limitation of all in single entity. But in the eyes of this writer, it's also the best.
-FS