Disadvantages of Securitization in Sports

In the previous articles, we have already seen how the use of securitization has grown in sports. We also know that the increasing use of securitization is because of certain benefits that are provided by this method of raising capital. However, it is important to note that securitization is a part of structured finance.

Structured finance in general and securitization in particular have a reputation for being quite risky. In fact, there are many critics who blame the excessive use of securitization in other sectors such as banking as being one of the main reasons behind several economic crises.

The use of securitization is also associated with certain disadvantages in the sporting sector. In this article, we will provide details about the various disadvantages that are commonly associated with securitization.

1. Additional Legal Costs: Firstly, it is important to note that securitization is not an easy-to-use strategy. The usage of this strategy requires the creation of a special-purpose vehicle. Then, a complex agreement for the sale of intangible assets needs to be executed. Also, the cash flows which are derived from these assets need to be ringfenced i.e. separated from other cash flows and a structure needs to be created so that these cash flows are passed on to the investors.

   A management company also needs to be appointed in order to administer these cash flows. All of this requires significant legal and transactional costs. Hence, even if the interest cost is lower, when these transaction costs are added, the economic advantage offered by securitization begins to pale in comparison.

2. Expensive to Reverse: The cash flow provided by securitization needs to follow a rigid schedule. This is because a lot of complex legal infrastructure has been put in place in order to execute such transactions. As a result, it is very expensive and difficult to reverse the transaction in case the sporting franchise no longer needs the loan. It is possible that they may have to pay a hefty prepayment fine.

   It is also possible that they may have to pay additional money in order to shut down the special-purpose vehicle. Hence, it can be said that the flexibility provided by securitization as a mode of funding is much lower than that which is provided by other modes of financing.

3. Limits Ability to take on More Debt: Theoretically, securitization is not directly affected by the bankruptcy of the sporting franchise. However, in real life, if the sporting franchise does go bankrupt, the cash flows to the investors are significantly impacted.

   It is for this reason that the creditors still want to ensure that the sporting franchise does not take on excessive debt and continues to be in a good financial state. This is the reason that there are covenants attached to securitization which legally limit the amount of debt financing that a sporting franchise can obtain after they have received the cash flows from securitization.

4. Possible Working Capital Issues: Many sporting franchises have run into cash flow issues in the recent past as a result of using securitization. It needs to be understood that there are certain expenses related to running the day-to-day working of the franchise.

   For instance, player and staff salaries have to be paid. Now, traditionally the cash flow received from assets such as broadcasting rights and ticket sales is used to pay off these current liabilities. However, when securitization is used, this cash is already pledged to the investors who have given the loan which was required for capital investments.

   As a result, it is quite possible and even likely that the franchise will end up running into working capital issues since they no longer have access to their main source of funding.

5. Operational and Credit Risk: It is important to realize that the investor continues to face operational as well as credit risk. In traditional securitization, the asset is simply passed on to the balance sheet of the lenders. However, in the case of the sports industry, the sporting franchise still needs to perform some operations in order to ensure that the cash flows are generated.

   For example, in order to ensure that the cash flow from gate revenue is generated, the franchise needs to ensure that the matches are indeed conducted. The same is the case when it comes to broadcasting revenue and digital rights. If the event cannot be conducted for some reason such as the Covid-19 pandemic, then the financial impact of such risks still falls on the sporting franchise.

6. Creates Inflation: Last but not least, it must be understood that a lot of funding that is raised by means of securitization is used to bid for the acquisition of players. Now, when a lot of franchises have access to these securitized funds, it creates an environment wherein they are able to bid larger amounts of money for players than they would have otherwise done.

   The final impact is that teams end up overbidding for players which creates an overall negative impact on their finances in the long run. The large-scale securitization of receivables has been one of the main reasons behind the rampant overbidding of players.

Hence, it can be said that even though securitization is a tool that can be used by sporting franchises to raise money, there are a lot of disadvantages associated with the same. It is important to understand that the method must be sparingly used in order to obtain the best results.