Co-edited by Scott J. Kaminsky: CFP ®, Financial Advisor, and Vice President of The KR Group at Morgan Stanley Smith Barney, LLC
One of the most interesting yet burdensome challenges a Professional Athlete faces is the endless abyss of business opportunities presented. Let’s face it, you have money and others want it. Or, at the very least, entrepreneurs know you have money, and want you to join their posse so that you can fund their project. Many of these opportunities can be extremely profitable, while others can be total shams. So how can you tell the difference? Or better said, what should an athlete, or any investor, look out for when considering a business or investment opportunity?
Notice how I used the words “Look out for” instead of “Look for.” The reason I chose these words is because, unfortunately, too many investors lead with “How much money can I make?” If you, the reader, can take one thing from this article, consider leading with, “How much money can I lose, rather than how much can I make?” And therein lies the first and most important point—RISK!
1) Never invest in an opportunity, no matter how seemingly great, if its failure could devastate you.
No matter how much profit could potentially come from a wise investment idea, if the result has the potential to do irreparable and permanent damage to your personal finances, the opportunity should be dismissed without hesitation. Consider this analogy. If your trainer described a new training technique which may improve your game by 20%, but the side effects could render you very sore for a few days, you may consider the benefits worth giving it a shot. However, if the side effects of this additional training technique could either cripple you or even kill you, I’m assuming most athletes would not take the risk. So then we ask ourselves, how much game time improvement would be necessary in order to accept the risk of a possible crippling injury caused by this new training technique? Hopefully, the answer is none.
Returning to the topic at hand, if we determine the level of risk to be too great, the profitability can be, in most cases, considered irrelevant. It's easier to tease yourself because you missed an opportunity, than it is to tease yourself because you went broke.
2) It is wise to be sure that ALL partners have money at risk.
Have you ever been presented an investment opportunity by an individual who claims that their experience is what they bring to the table? It’s very important to realize that individuals behave different when risk is at hand. If a leader of an investment group has your money to risk but not their own, there is a high probability that they will accept significantly greater risk because, at the end of the day, it’s not their money they’re risking. This is such an important concept to understand, especially for Professional Athletes who represent a wealthy cross section of the public with limited financial experience.
A traditional partnership is made up of General Partners (the decision makers) and Limited Partners (those without decision or voting rights.) This structure is very common and should not be perceived as dangerous simply because not every investor is a decision-maker. In fact, if you think about it, do you really want every partner to have an opinion? After all, this article is predicated on the idea that certain investors don’t have the necessary education to make informed decisions. As such, the General Partners (decision-makers) should be those that are financial professionals.
Nonetheless, it is important that all investors have something to lose. This fundamental concept puts all partners on the same page. By no means does this single concept ensure that all partners are in agreement, but it’s a start.
3) Consider dismissing any investment lacking transparency
On a personal note, I was recently approached by a self-proclaimed investment professional, who presented a “Can’t Miss” investment opportunity. Unfortunately, this opportunity was highly confidential. In fact, it was so confidential that even the limited partners were not allowed to know exactly what the opportunity involved. Need I say more?
4) A financial investment should contain reasonable expectations of financial reward.
Often, individuals may be presented with a business or investment opportunity where the claimed benefit to the investor is reputation, networking, etc., etc. While this may seem like a good idea as long as money is not lost, let’s consider why such an investment is being made.
Chances are that an investment is created for profit at some point along the chain of command. Unless you’re working with a Charitable Organization as many of us do, a for-profit business opportunity, including all the labor and time necessary, is not created simply for kicks. Therefore, the likelihood is that someone is making money. Otherwise, why even waste time presenting this opportunity to folks like you. And if we conclude that money is being made by someone, why aren’t you getting any? I can think of only one reason: Those who are making money don’t care that you’re not making money. And if this final point is true, then the business partners you are considering working with are either selfish, unethical, or don’t understand the concept of a business partnership. If any of these three reasons are prevalent, I wouldn’t want to do business with those people; would you?
5) The leader of the pack should have significant experience in the business proposed and should be able to provide document thereof.
In the recent research study titled 5 Biggest Challenges Facing Professional Athletes, there are several instances of highly successful athletes who engaged in businesses related to sports, but due to a lack of business experience, struggled to keep these opportunities afloat. Simply put, do not assume that an athletic professional understands the business of athletics just because they have been around sports for their entire life. In some cases, they do, but in some cases they do not, and this can be a tough lesson to learn. Some have learned this gracefully, some unfortunately have not.
As this point pertains to business opportunities, be certain the decision-makers have significant experience in the business side of whatever endeavor is being proposed. And we strongly suggest you not take them at their word. Request documentation and request references. Most importantly, find a financial professional to validate this documentation. Sometimes, just as common as not asking, is asking only to receive fraudulent, incomplete, or simply irrelevant documentation.
6) The concept of a “Preferred return”
Earlier in this article, I mentioned the dangers of a General Partner behaving in a way which may not be in the best interests of the partnership if they have nothing to lose. That said, you may be presented with a business opportunity in which a General Partner has money at risk, but also gets a “Preferred Return.” Often, this preferred return is compensation for the leading partner bringing experience and know-how to the table. This is very common among Real Estate Partnerships where a developer may serve as a General Partner while other monetary investors may be more like “Silent Investors.” This is commonplace and usually acceptable as long as the Preferred Return is appropriate. So… what’s appropriate?
a) No partner should receive any profit until all partners have recovered their original investment.
b) Usually but not always, the preferred return should not kick in until some reasonable amount of profit has been earned by everyone.
c) The preferred return should be in line with the industry standard in which the opportunity takes place.
d) The preferred return should not be perpetual—meaning, after a reasonable extra kick has been earned by the General Partner, the profit above and beyond that threshold should return to equal distribution among all partners.
e) All of this should be in writing.
7) Have your own legal counsel
Is it not uncommon for a business partnership to hire counsel for a range of different services. Among these services may be creating the legal partnership entity, working with subcontractors, as well as drafting a written partnership agreement. Assuming a lawyer retained by the partnership does indeed draft this partnership agreement, be sure to have your own independent counsel review the agreement. There is little way for you to know if the attorney is getting a kickback, so unless the document is reviewed by an impartial party, there may be no way for you—the investor at risk—to know if the agreement is fair.
We hear too often about trusted advisors disappearing with celebrity money. Please don’t be that statistic. Do not agree on a hand shake, do not trust blindly. As the 40th President of the United States, Ronald Reagan, once said, “Trust, but verify.” And as Ben Franklin once said, “To trust by faith alone, is to trust blindly.”
It’s an unfortunate reality that even those perceived to be close to you sometimes can’t be trusted. While I rarely use names, I have no qualms about naming Lenny Dykstra whose dishonesty knew no bounds as he scammed both friends and family alike.
There are too many things to consider in the space of a single article. However, we’ve mentioned a few bullet points which we hope will help dramatically. The depth that some will go to in order to separate you from your money, is nothing short of astounding. Be sure you have appropriate counsel. Every player needs a coach on the field; every player needs a coach off the field. It’s the latter that’s often missing and the results can be devastating.
Something to think about...
The views expressed herein are those of the author, and do not necessarily reflect the views of Morgan Stanley Smith Barney or its affiliates. All opinions are subject to change without notice. Neither the information provided nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. Past performance is no guarantee of future results.
© 2011 Morgan Stanley Smith Barney & Citigroup Global Markets Inc. Member SIPC.