Investors Buying Stock in NFL Player through First Fantex IPO

Posted by Noam Noked, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Saturday May 10, 2014 at 9:00 am
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Editor’s Note: The following post comes to us from Brian Korn, of counsel in the Corporate and Securities Practice Group of Pepper Hamilton LLP, and is based on a Pepper Hamilton publication by Mr. Korn and Andrew D. Kupchik.

On April 28, 2014, shares of Fantex, Inc. (Fantex), which are linked to the performance and earnings of Vernon Davis, star tight end of the San Francisco 49ers, were sold to the public. Other professional football players for whom Fantex has filed initial public offering (IPO) registration statements include quarterback EJ Manuel of the Buffalo Bills and running back Arian Foster of the Houston Texans.

What Is Fantex?

Fantex is an online securities exchange that is a member of the Securities Investor Protection Corporation (SIPC) and Financial Industry Regulatory Authority (FINRA).

How Does Fantex Work?

Professional football players (and possibly in the future professional athletes of other sports and other celebrities) that want to be traded on Fantex are vetted through a typical IPO process. The process starts when Fantex files a registration statement with the U.S. Securities and Exchange Commission (SEC) detailing the information on the stock to be publicly offered, including information about the associated athlete and his or her playing contract and endorsements. Each athlete listed on Fantex will be identified by a different series of stock of Fantex. Once the review and comment period with the SEC is complete and the registration statement is declared effective, investors can buy such shares.

Investors do not purchase shares of the actual athlete. Rather, investors are purchasing “tracking” shares of Fantex that reflect the separate economic performance of a brand contract that Fantex has signed with the athlete. For example, subject to certain caveats, Fantex has entered into a brand contract with Vernon Davis whereby 10 percent of his salary, bonuses and other compensation received in connection with football, including endorsements, television appearances and speaking engagements, will be paid to Fantex. The brand agreement also covers other football-related income received by Davis, including income from coaching and broadcasting. Put more simply, the more money that Vernon Davis makes, the more money that Fantex makes, which in turn should drive up the price of the shares “tracking” Vernon Davis. Shares will not be listed on a more traditional stock exchange such as the NASDAQ Stock Market or the New York Stock Exchange. Instead, investors can buy and sell these shares with other willing investors only on Fantex’s new online exchange.

Why Do Professional Athletes Agree to Remit 10 Percent of Their Earnings?

A professional athlete, like Vernon Davis, that enters into a brand contract with Fantex receives the net proceeds from the IPO of the shares sold. There are no underwriting fees deducted from the net proceeds, as there would be in a conventional IPO. An athlete that lists on Fantex typically earns compensation based on the potential of his earnings and the valuation of potential earnings depends in part on the volatility and risk of the athlete’s earnings. The earnings of an NFL player are particularly volatile—many careers end prematurely, injuries are prevalent, competition for roster spots is intense, playing time is limited and highlight-level plays are even less common. A player might not receive any income if he fails to make the team or becomes unable to play. Moreover, many sports team contracts allow for modification by the team if it needs room under the league-mandated salary cap to pay more to another player. The amount of the compensation that may be earned is also based on the valuation of that athlete’s earning potential and the perceived value of that athlete’s “brand.”

Fantex assigned a present value for Vernon Davis’ future earnings of approximately $40 million. In exchange for Fantex receiving 10 percent of his future earnings, Vernon Davis will receive a lump sum of approximately $4 million, assuming the sale of all of the shares linked to his earnings. Of course, over time an athlete might make far more or far less than the assigned valuation, which provides the incentive for his “tracking” stock to trade. Events that enhance brand income should increase the stock price, such as a new contract or endorsement. Events that reduce brand income should decrease the stock price, such as an injury, being released from a team, a promising new star who might be perceived as possibly replacing Davis being drafted, or legal troubles.

Key Points:

  • Fantex is part of a growing crowdfunding trend of the individual annuitizing his or her own revenues. Another company, pave.com, offers future payment streams of promising young professionals who agree to return a fixed percentage of their income over a shorter period, usually five years, in exchange for a lump-sum payment. This follows on the premise that investors might be better at valuing people than they are at valuing enterprises.
  • Athletes should retain legal counsel before considering to list on Fantex to ensure that their interests are adequately represented. As would be the case for any IPO issuer, counsel would review and negotiate the underlying brand contract and oversee the offering process as it wends its way through the SEC and then on to closing with the investors in order to help ensure that the process complies with the myriad technical laws and regulations involved.

In addition, it is in the interest of Fantex to see an athlete listed on their exchange make more than the athlete otherwise would. For example, Fantex plans to promote the brand of Vernon Davis after the IPO of the shares linked to him are declared effective by the SEC. This commitment can help an athlete earn more than he otherwise would have, had he not been listed on Fantex. Plus, the novelty of the Fantex IPO is marketing in itself.

  1. 1) Why is the security purchased a tracking share of Fantex? Why not just chop up the underlying contract with Vernon Davis into a bunch of different securities sold to the public? (Not saying its a bad idea, but is there a legal reason why it is structured this way?)

    2) Vernon Davis & Arian Foster are past their peak in terms of performance, so they are not good players to gauge the market interest because they are known commodities that can be fairly easily valued. But EJ Manuel is very interesting because he is still a bit of a mystery. I can see this system working very well and being very popular with obscure, later-round draft picks.

    3) Are there any issues with gambling laws?

    4) The biggest issue will be getting around/dealing with the agents. The NFLPA is run by the agents. Will agent fees somehow be affected?

    On the whole though, I think this is a great idea. Michael Lewis wrote about the theory behind this about six years ago for an article in Money Magazine (I believe).

    Fascinating stuff.

    Comment by John Park Williams — May 10, 2014 @ 11:04 pm

 

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