The 51 Percent Solution

I must say, I quite like the cut of this Fake Sigi Schmid guy’s jib. I’ve just recently discovered him and I wish I knew who he was. (He’s much better than Not Doug Logan, who is apparently also Not Pretending to Not Be Doug Logan Anymore1.)

This is a good analysis of MLS’ single entity structure, with a very good conclusion: that no, it’s not something you do for a while to get up and running, it’s a structure you stick with long-term.

I do have a minor bone to pick, and it’s largely a semantic one, and I wouldn’t mention it except that I’ve had to point it out to another blogger over and over in increasingly not-so-nice terms. Fake Sigi doesn’t explicitly say this, but it’s only a matter of time before said blogger writes “See! I told you so!” and since my 2010 resolution is to not read anything at that particular website, I’ll just say my piece after the jump.

Here’s the relevant piece of Fake Sigi’s post (which, again, doesn’t explicitly state the canard I’m about to debunk):

MLS LLC is a limited liability company with single taxation and partners that own it who are a mixture of corporations, partnerships and individuals. MLS owns all of the teams that play in the league (a total of 12 prior to the start of 2002), as well as all intellectual property rights, tickets, supplied equipment, and broadcast rights. At the same time, 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.

While it’s true that MLS, LLC is a limited liability company and has investors (and investor/operators who actually run teams, in addition to investors like Alan Rothenberg, who do not), I need to clarify the concept of MLS “owning” its teams. Over the years, it’s gotten stuck in some people’s minds – again, not Fake Sigi’s, but many on Bigsoccer – that single entity means MLS, LLC “owns” 51 percent of each team, giving it, in essence, control of everything.

But what gives MLS control over its franchises is the franchise agreement it makes with the investor/operators. The only “51 percent” control MLS, LLC has over its franchises is much like the reason your dad got the last pork chop or the Vice President gets to cast a tiebreaking Senate vote – it’s their game. They’re their franchises. MLS, LLC doesn’t “own” 51 percent of the stock in a franchise (the normal way an individual or a block would have “control” over a corporation), it has at its disposal a number of licenses to conduct Major League Soccer games in a given territory, and it can assign, create, disband, revoke or otherwise dispose of those franchises as it sees fit, subject to the terms of the franchise agreement.

But MLS, LLC doesn’t “own” 51 percent of the stock in DC United. Will Chang bought out his other partners in DC United and now “owns” 100% of the operating rights2 – in essence, the franchise/club – to DC United. When the Chang/McFarlane/Davis/Laettner group bought DC United from Anschutz Entertainment Group in 2007, they paid AEG $33 million. Hold that number in your head for a second.

If – as some say – MLS, LLC “owns” 51 percent of each team, wouldn’t that put the value of DC United at more than $66 million? If AEG couldn’t have owned more than 49 percent of the club and Chang et al paid $33 million for that, what did MLS (the owner of the other 51 percent) get? And if that $33 million went to AEG and MLS, LLC (some of it may have been diverted, MLS takes a cut of a lot of things), that would mean that AEG only got about $16.2 million. (The proposed 2005 sale to a group led by current club president Kevin Payne didn’t take, and it was for $20 million.)

And if AEG only got $16.2 million for their just-less-than-half of DC United, they got hosed, because Oscar de la Hoya and Gabriel Brener paid a combined $20 million – to AEG, no less – for half of the Houston Dynamo less than two years ago. If they could only buy half of the 49 percent, that would put the value of Houston at more than $80 million. And with expansion teams (which MLS can just create out of whole cloth) going for $35 million (after an original asking price this last time around of $40 million), you can see where there’s a disconnect.

MLS controls its franchises. MLS ultimately decides what happens to its franchises. The “owners” (investor/operators) of MLS clubs own stakes in MLS, LLC, which, in its single-entity model, controls player contracts and league-wide marketing and media deals.

But MLS, LLC does not “own” 51 percent or any percent of the stock in its franchises. Each franchise is operated by one of (now) 16 separate holding companies (Phil Anschutz had several different ones for his different franchises when he owned half the league’s teams – Chicago’s was “Anschutz Chicago Soccer,” for instance), each with their own stockholders and profit & loss ledgers. While MLS, LLC takes a percentage of ticket sales from each club, a piece of the sales of shirt sponsors, etc. and gives each club a percentage of things like transfer fees, it is NOT a situation where MLS, LLC owns 51 percent of each of its clubs3.

Controls (at the end of the day), yes. Owns, no. That’s the sum of the bone I have to pick – less so with Fake Sigi, who, as I’ve said, I quite like.4

1 – Seriously, his stuff is so funny in retrospect. Like listening on Monday to Ron Jaworski picking NFL games from the previous Friday’s Tony Kornheiser Show. And, yes, I’m putting footnotes in here because I just got done reading Bill Simmons‘ 700+-page Book of Basketball. Sue me.
2 – I’ll take Steven Goff here over Richard Snowden, thank you very much, Bill.
3 – I should mention that my basis for this conclusion was a very long conversation on a very long red-eye flight from the west coast with a longtime MLS executive, who explained the whole thing to me in great detail about five years ago. If he was wrong or lying, I’m going to punch him in the face.
4 – No, it’s not me.

15 thoughts on “The 51 Percent Solution”

  1. Thanks for clarifying the ownership question. Was wondering about that since reading it this week.

  2. Thanks for the link and the kind words. You know you’re me.

    I’m sure it’s because I’ve been thinking about this all day and my brain is fried, but being that owner/operators need to have a stake in MLS LLC and in the operator rights, I wonder how much each portion is worth relatively. You would assume that the stake in MLS would be the more valuable part, as contractors see a just subset of MLS revenue.

    What I’m getting at is I’m wondering about that Houston arrangement. GBE must have bought a share of MLS LLC in addition to the operation rights, but that was never broken out in public to my knowledge.

    -FS

  3. If I understand your explanation, then MLS is akin to McDonalds corporate (i.e., franchisor) and the team owners are akin to McDonalds outlet owners (i.e., franchisees). Is that correct?

  4. Kinda sorta.

    If you “buy” a KFC franchise, what do you get? The right to operate a restaurant that carries the KFC name and logo and banner and signage and brand equity, right? And (depending on the franchise agreement), you agree to do certain things and kick back a certain amount of certain revenues to the home office and they agree not to put another KFC on the next block. The “franchise” is what’s valuable. You can have a chicken restaurant without it, but then they CAN sell a KFC franchise to a guy on the next block and hurt your business.

    As for the investment in MLS, LLC, that is interesting, Sigi. There’s a concurrent investment in MLS, LLC, wouldn’t you think? That doesn’t get reported? I used to have an LLC (years ago), and there are rules about who gets to be in and how and their level of investment, right? If you add a team and therefore add an investor in MLS, LLC, don’t you sort of have to “create” stock where there was none? There is not, to my knowledge, an intrinsic cap on the number of investors MLS, LLC can have, but if you had, say, 10 investors (I know they’re not all equal) and you add a few more, is the stock you bought as one of the first 10 worth more or is it diluted by virtue of there being more investors down the line?

    I don’t know. But I believe that Rothenberg, in the trial, testified that there are different levels of stock in the LLC. Some non-voting stock, I believe. Some that comes at the investor/operator level and some that comes at the strictly investor level (like a Dentsu). If there’s a $33M purchase price, just as an example, does it all go to the former owner? Is there a separate MLS, LLC (and SUM – which was originally said to be a separate company, albeit with many of the same investors) investment that has to be made on top of that? I don’t know. I would like to know.

    But, again, in my mind, the “MLS owns all of its franchises” thing is a semantic argument. At the end of the day, they control them, yes. They have the sort of veto power that comes from “My House, My Rules,” which I’m sure we’ve all dealt with as teenagers. But semantically, while MLS has the ultimate disposition of the ethereal entity known as DC United, Chang “owns” 100% of DC United Holdings, which has, as its most valuable asset, the sole and exclusive rights to stage Major League Soccer matches in the territory of the District of Columbia.

  5. Rothenberg testimony from way back when:

    17 And you are an investor in Major League Soccer,
    18 correct?
    19 A Yes.
    20 Q And, Mr. Rothenberg, do you currently have an investment
    21 interest in Major League Soccer?
    22 A Yes.
    23 Q Okay.
    24 What percentage interest do you have?
    25 A Approximately 4 percent.

    page 3371

    1 Q Four percent?
    2 A It’s a C unit in the league.
    3 Q Now, did you pay any money to get that interest in Major
    4 League Soccer?
    5 A Yes.
    6 Q Okay.
    7 How much did you pay?
    8 A It was divided — the initial payment was $100,000, and
    9 over the past five years, I’ve probably put in several
    10 hundred thousand dollars more as more capital had to be put
    11 in.
    12 Q And for that you own 4 percent of the entire league?
    13 A Yes, but it was in two parts in the sense that I was
    14 granted a certain equity position based on what’s called
    15 sweat equity, working for it, and the other part was what I
    16 paid for but the aggregate is 4 percent, a little under
    17 4 percent.
    18 Q You were given 3 percent, I think, for the work you did
    19 for the league; is that correct?
    20 A And also I entered into an agreement to be a consultant,
    21 and it was to do ongoing work for the league, yes.
    22 Q And as part of your work starting up the league, being a
    23 consultant, you were given 3 percent?
    24 A I think that’s right. And then, as I said, I also
    25 invested on top of that and just because there’s been

    page 3372

    1 changes in ownership over the period of time, I think my
    2 equity interest now is somewhat closer to 4 percent, and I
    3 put in several hundred thousand dollars of additional money.

  6. More from Rothenberg:

    A. The ultimate corporate structure that we created for MLS was something called a “limited liability company.” Under our limited liability company, the group that manages it is the — is the management committee. Most sports leagues tend to call their managing group a board of governors. So somewhere midway in between we just gave it the name board of governors. It continued to function as the managing group of MLS which is, as I said, a limited liability corporation, an LLC.
    Q. And you were always on the Management Committee or the Board of Governors throughout the existence of MLS?
    A. Yes, sir.
    Q. Okay. Now, each of the investor/operators has had a vote on either the Management Committee or the Board of Governors; is that correct?
    A. Each A unit holder has a vote.
    Q. And when you say an A unit holder, the A unit is what gives you the right to run a particular team?
    A. Yes. The way we structure it, there were different kinds of ownership. The A unit referred to an investor who was also an operator, and so each — the owner of each A unit got one seat at the Management Committee or Board of Governors table.
    Q. So I’m going to call them the investors/operators rather than refer to them as the A unit, if that’s okay?
    A. Sure.
    Q. And you know each of the owner/operators is a defendant in this case?
    A. I — I’m not sure who the defendants are, other than MLS itself and the Federation.
    Q. Now, the investor/operators would have the majority of votes on the Management Committee or the Board of Governors; is that correct?
    A. Yes.
    Q. And so —
    A. By number, yes.
    Q. Okay. So if the investor/operators vote by majority, that sets the policy of MLS; is that correct?
    A. In most cases. My recollection is that there is some things that are in our documents that require a super majority, so it’s not the case in every instance.
    Q. Now, Mr. Rothenberg, you were involved in soliciting all of the initial investor/operators of MLS; is that correct?
    A. Yes.
    Q. Okay. And originally how many investor/operator groups were you successful in bringing into MLS?
    A. I’m not sure I understand your question.
    Q. Well, in other words, how many different investor groups, investor/operator groups, were you able to bring into MLS when it first started in 1995?
    A. Those that came in once we became official, were — and I may not have these as corporate names, but it’s the Kraft family. It was the Kluge/Subotnick partnership. It was the DC United Group, which had a general partner which was a company called API. It was the Hunt family, and it was Phil Anschutz’s Company as the investor/operators. And then it was a subsidiary of Dentsu, Japanese ad and PR agency, that was a B unit holder, nonoperator/investor, and myself. I guess I solicited myself.
    Q. Now, you were not an operator originally, correct?
    A. Yes.
    Q. Okay. And Dentsu was not an operator, right?
    A. Right.
    Q. Right. What about Mr. Rapaport’s group?
    A. Oh, I’m sorry, thank you. In Los Angeles, yes, there was a group headed by Mark Rapaport.
    Q. Okay. So —
    A. Don’t tell him I forgot.
    Q. So I think you’ve identified that there were six investor/operator groups in 1995? That’s correct?
    A. Yes.
    Q. And that’s because three of the teams were run by the league, correct?
    A. Yes.
    Q. And the tenth team was also run by Mr. Hunt’s group, correct?
    A. Yes.

  7. So where did you find that transcript? I’d be interested to read more.

    After much reading, I’ve deduced that being the owner of a class A membership unit in MLS LLC is what gives you the right to operate the team. If you’re class B or C, you share in the losses and profits of MLS, but you do not receive any of the local revenue that the operator investors see, nor are you putting out money to operate the team. This is more or less what we’ve both said, but let me go through it.

    The way it works is 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, which then gives them the right to have MLS contract with them to operate the team. Maybe that A unit is divisible, maybe it’s just an equal share that flexes in percentage as operator investors come and go. Let’s assume the latter right now, although I’m not sure it matters either way.

    Now, you can hold that A unit however you want. If it’s through a corporation or partnership, you can then sell various shares in that entity to other investors. I suspect this is how most of the A units are held, and it’s how teams have local investors that are only investors in MLS LLC indirectly. Maybe they 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, in addition to the profits and losses of operating a team in their home territory, in addition to being able to bring on “local” investors in that entity.

    So. When you buy “a team” what you’re really buying is a share of MLS LLC in a class of membership that gives you the right to operate that team, a share of revenues from operating that team, and a share of revenues in MLS. Obviously, MLS LLC owns the team, IP, and all that jazz.

    Applying that to the examples here, the Chang group paid AEG ca. $33mm for the A Unit investment in MLS that gave them the right to operate DC United. The only people who would have seen money from that transaction were the people who had an interest in that A Unit, either directly or via its holding entity – MLS LLC would not have taken a cut. Chang then bought out the other investors who had shares in the entity used to purchase the A unit.

    Re: Houston, AEG must’ve sold half the interest in the entity that owns the A Unit that gave them the right to operate Houston.

    So the bottom line is that MLS does not own half of the entities that own A units – the A units are how the entities that run the teams own MLS, and at the same time get the right to operate a team. It is a little convoluted, and yet it is pretty obvious once you break it down.

    –There is not, to my knowledge, an intrinsic cap on the number of investors MLS, LLC can have, but if you had, say, 10 investors (I know they’re not all equal) and you add a few more, is the stock you bought as one of the first 10 worth more or is it diluted by virtue of there being more investors down the line?

    It can be both – when Toronto or Seattle came on, the A units of the other owners were diluted as a percentage of the LLC, but I’m guessing their value increased because of the new revenues brought in.

    I should wrap all this up in a blog post. Content reuse = win.

    -FS

  8. “So the bottom line is that MLS does not own half of the entities that own A units – the A units are how the entities that run the teams own MLS, and at the same time get the right to operate a team. It is a little convoluted, and yet it is pretty obvious once you break it down.”

    And THIS is what I think I’m getting at. I consider “the entities that run the teams” to be the teams themselves. And MLS does not own them, the investor does, by virtue of being A Unit investors. Like a PSL, almost.

    All that said, what little I know about LLCs includes that the agreement that creates the LLC in the first place usually includes language about the ultimate disposition of those shares, correct? And, at the end of the day, Chang could be out of luck if the LLC decides to strip him of DC United for high crimes and misdemeanors. Which is not – I contend – exactly the same thing as “owning DC United” or “owning 51% of DC United.”

    That is my only point, really – there is (indeed, there likely never was, unless it was in the primordial soup days) no scenario under which “MLS owns 51% of every team, with its investor(s) owning the other 49%.” No matter how many times people try to say that’s how it works.

  9. Great analysis.

    Question is, do you have a problem with a league that controls the outcomes of all matches through control of clubs? I mean, I like to flip coins, hit the one armed bandit, shoot craps, but does randomizing match outcomes through heavy handed controls on club autonomy make for good soccer? Can parity stand in for performance?

    The majority of American soccer supporters – if they vote with their TV viewing habits, appear to say no.

  10. Dear God – you again?

    Where do you make the leap from “control of clubs” (which is not exactly as you’re positioning it) to “control the outcomes of all matches?”

    Are they making the ball bounce a certain way? What is it?

    TV viewing habits for the domestic soccer league in this country are largely what they’ve always been – and that goes back to the league that wasn’t single entity – and EXACTLY what they’d be in your pie-in-the-sky “open pyramid” scenario.

  11. Here’s my question: When foreign players are signed (players who aren’t drafted), does MLS dictate what team they will play for or do the “owners” go out and find these available “free agents” and convince them to come play for their team?
    For example, did Kasey Keller get convinced by the Sounders to come play for them or did MLS say “Good news, Seattle Sounders owners: you’re getting Kasey Keller.”?

  12. Keller said “Guess what? I’m playing in Seattle or I’m not playing.”

    Keller nearly signed with Real Salt Lake a few years before that, before Seattle was on the MLS horizon.

    A really, really, really big player can pretty much dictate where he’s going to play and then the machinations to make that happen kick in. Or if there aren’t machinations to cover it, MLS just makes them up.

    In the beginning, MLS allocated stars around the league to make sure everybody shared the wealth. Eventually they loosened that and teams largely go after the people they want to go after.

  13. That’s what I was looking for an answer to, thanks. I remember the early years of MLS when they dictated who played where. I was hoping that had changed and I’m glad to hear that it has.

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