Multi-millionaire pro athletes and cash-hungry startups - a good fit?
INSIGHT ARTICLE |
There has been some recent news coverage of a venture to bring pro athletes from across North America together with local tech entrepreneurs looking for financing. This has been positioned as a good-news story, though it could turn out very badly.
The premise for the venture is based on the idea that professional athletes are among the highest-paid individuals in the world – but for just the few short years of their careers. They often need further income streams post-retirement.
At the same time, Canadian startup companies, often in the tech sector, have a notoriously difficult time getting financing. They need investors who are patient and willing to take a chance on a new idea.
Taking unwise risks with retirement savings
Is this a marriage made in heaven? At first glance, it looks good.
On one hand, pro athletes definitely need a sound strategy for their post-retirement finances. However, there have been many studies about the lives of professional athletes following their playing careers, with some focusing on their distressing financial positions.
This was highlighted in the ESPN documentary, Broke, and in the Sports Illustrated article “How (and Why) Athletes Go Broke”, where it was revealed that 78 per cent of former NFL players had gone bankrupt or were under financial stress just two years after retirement.
This is partly because while the athletes have worked hard to learn and practice the skills of their game, their expertise does not often extend to financial management, investments and the diligence required to assess opportunities fully. And, most athletes retire from their sport at an age when many people’s careers are just taking off – leaving a lot of years with living expenses to meet.
That need can sometimes cause a retired athlete to take unwise risks with their savings. Based on their status, they see numerous opportunities and what entrepreneur would not want a professional athlete adding their name to their company. However, there are too many examples of athletes’ money difficulties that come from having poured significant parts of their savings into an entrepreneur’s “sure thing” business opportunity, that didn’t work out.
The risk of direct investing in early stage companies cannot be overstated. Around the same time as Broke was being aired, Shikhar Ghosh of the Harvard Business School published an article in the Wall Street Journal titled “The Venture Capital Secret: 3 Out of 4 Start-Ups Fail.” The article referenced sources showing that about 75 per cent of U.S. venture-backed start-ups fail, and about 95 per cent of venture-capital-backed companies fail to deliver their projected return on investment. While the statistics could be debatable, what is not up for debate, is that investing in early stage companies is risky and investors should be prepared to lose all of their investment given the dynamics of companies at this stage.
The need for a smart way to invest surplus earnings
These statistics point to the need to put the right checks and balances in place, to ensure long term financial freedom for professional athletes post-career. Many athletes might see investing in a tech company with dazzling projected returns to be a good way to secure their future. However, playing to one’s strengths, as any professional athlete knows well, actually leads to better long term success.
That includes finding and relying on the expertise of others when appropriate. Athletes know the importance of relying on the specialized knowledge of their coach, in seeking to improve their performance. In the same way, it is more fiscally prudent for professional athletes to find trustworthy, specialized professionals to help plan their investments, rather than invest their capital directly with tech and other early stage companies.
Investing into a venture capital or private equity fund allows an athlete to access the skills and knowledge of a manager who, typically, has deep expertise in identifying, assessing, monitoring and exiting investments over a long period of time. Their track record can be assessed based on historical returns, making it easy to see their record of wins and losses.
In addition, investing in a fund allows an athlete to diversify their risk away from any one single investment, into a basket of opportunities.
Of course, there is a cost involved, but it is well worth the while. The cost of investing in a fund, rather than directly, is typically limited to the management fees (usually 1- 3 per cent) charged on funds invested, and a share of the profits on a capital return retained by the manager (usually 20 per cent).
A further benefit of investing retirement savings through a qualified manager of a venture capital or private equity fund is the value they add to the business, in addition to their capital. Just as a good sports coach maintains a network of other professionals who can be brought in to deal with unusual situations, a good manager will use their expertise and networks to supplement the business plan the company is building upon to generate good results.
Another option is for the athlete to work with a team of advisors to fully assess the risks on each deal before committing capital. The team would include legal, financial, operational and market diligence experts who can assist in identifying all the risks before an investment.
These are one-time costs at the outset of a potential investment, so there will not be any ongoing fees. The downside is that this option does not provide the benefit of a team of professionals to carry out the ongoing monitoring, governance and strategic support that investing through a fund would allow.
Chasing the dream of investing in the next unicorn venture capital deal can be alluring to professional athletes while they are at the height of their playing careers, earning multi-millions of dollars per year.
However, not accessing professional investors who have a deep track record and expertise in the venture capital investment space is risky and can lead to significant financial losses.
Professional athletes should focus on their strengths on the playing surface, work with their agents and managers to focus on partnership opportunities with brands and companies aligned with their values, and ensure they utilize the skillset of professional venture capital and private equity managers unless they develop their own expertise in the field of financial investing.