Arian Foster retired on October 24, 2016 as an NFL running back at the age of 30. Foster had gone undrafted out of the University of Tennessee in 2009 but made the Houston Texans roster. In 2010 he led the NFL in rushing and had strong seasons in 2011 and 2012. But Arian Foster is also known as the first professional athlete to try to sell shares in his future earnings, turning himself into a securitized asset.
In October, 2013, Foster was in the second year of a five-year contract worth $23.5 million. A company called Fantex planned an initial public offering (IPO) for 1,055,000 shares at $10 each of a “convertible tracking stock” that would be supported by 20% of Foster’s future income (with some exceptions for some non-football related pursuits). Foster was to receive $10 million with the remainder going to Fantex, and Fantex would also receive 5% of the future earnings. If Foster were to retire within two years for reasons other than illness or injury he’d have to pay back the IPO and if his “brand” dwindled to nothing the shares would convert to shares in Fantex. The shares would trade only on Fantex’ proprietary exchange.
Immediately after the announcement, Foster re-injured his hamstring but was still able to play. The IPO was cancelled for good when Foster had back surgery in November, 2013.
Arian Foster is hardly the first person to create a security to get paid up front. Rock star David Bowie was in need of cash in 1997 but he did not want to sell his catalog of music, as many other musicians had done and later regretted. Instead, the “Bowie bond” was created. This bond raised $55 million, paid 7.9% interest from royalties and licensing of Bowie’s first 25 albums, received an investment-grade rating and had a 10-year maturity. Prudential Insurance bought the entire issue and although the bond’s rating was lowered in 2004, all interest payments were made on time, the principal was paid at maturity and the unencumbered rights to the music returned to Bowie.
The adviser who helped create the Bowie bond did the same with other artists but kept those bonds in his firm’s investment portfolio rather than selling them to other investors.
While it may seem exotic to invest in an athlete or a rock star, these investments are really no different than most securities. The securities markets create vehicles that enable investors to participate in the value of an asset (whether it’s a start-up company, natural resources or real estate) or in some anticipated stream of revenue (whether it’s income generated by an industrial project, a portion of profits from a financial firm or tax revenues collected by a state or local government).
Most securities are initiated by the entity with the asset or income but sometimes investors create a vehicle to attract parties with income streams to sell. A good example is the ads that say “it’s my money and I want it now”. These firms are offering to “buy” the payments from structured settlements (often awarded in personal injury cases), lottery winnings or annuities. The initial creation of the ongoing income was either the result of the legal settlement or by choice of the lottery winner or annuity buyer. Sometimes circumstances change such that a lump sum is preferable to pay off debts, buy a home or invest in a business.
The details of such a transaction, however, raise questions as to who benefits more. The income stream is purchased at a “discount rate” which is similar to a rate on a loan, so the higher the discount rate the smaller the lump sum, and the firms that buy these income streams are clearly looking to profit from the deal. Structured settlements can be sold only with the approval of a judge to prevent any abuses and there has to be a legitimate need rather than simply the whim of the income recipient. For lottery winners, selling the payments at a discount creates a large one-time tax liability, which is presumably one of the reasons the ongoing payments were chosen in the first place. For annuity sellers, there may be surrender charges as well as tax penalties if the seller is not yet age 59 ½. In all cases the lump sum could be lost through poor decisions or unwise investments, forfeiting the security of the guaranteed payments. For all those reasons, many advisers recommend first considering a bank loan which can be repaid with the ongoing payments and being very careful about limiting the amount of the ongoing payments that are sold. Once it’s gone, it’s gone.
What happened to Fantex’s idea of selling an interest in an NFL player? Shortly after the Arian Foster deal fell through in 2013, Fantex sold a $4 million issue backed by 10% of the earnings of Vernon Davis, then a tight end for the San Francisco 49ers. Davis had previously signed a five-year, $23 million contract in 2010. Vernon Davis is still in the NFL with the Washington Redskins and his shares (symbol VNDSL), which were issued at $10, have received portions of Davis’ income and are now trading at $1.39.
Fantex raised $60 million of its own from private investors in 2016. It has issued shares in 20 athletes, 10 from the NFL, six from Major League Baseball and four from professional golf.