eSports Investments: Virtual Games Require Real Due Diligence

Authors: Irwin A. Kishner and Erica L. Markowitz

It takes a lot to pack New York’s 18,000-seat Madison Square Garden, which has hosted some of the greatest sports and entertainment events of all time. Last fall, the arena was sold out on two consecutive nights, but the fans weren’t cheering for the Knicks’ Carmelo Anthony, or Rangers’ captain Ryan McDonagh. Instead, they passionately followed the moves of “jungles,” “supports” and “top laners” from around the world, playing a video game called League of Legends.

To say that eSports is having a moment in the sun is an understatement. Last year saw a plethora of investors – everyone from team owners and celebrities to private fund executives – turn their focus to eSports. And the slew of investment activity is expected to continue as the industry matures. The Philadelphia 76ers acquired not one, but two teams – Team Dignitas and Team Apex; while the investment group aXiomatic, which includes Steve Case, Tony Robbins and Magic Johnson, bought the Dutch-based Team Liquid. The co-owners of the Sacramento Kings also bought Team Coast, and then proceeded to rebrand the team as NRG with help from investors Shaquille O’Neal, Alex Rodriguez and Jimmy Rollins. Even celebrity DJ Steve Aoki got into the game by buying a majority stake in Rogue, a team that plays five popular games.

All of the relevant metrics seem to point to eSports rivaling, or even exceeding, the size of other major international sports. But investors coming to the deal table are not guaranteed a slam dunk. Many leagues that have formed around top games remain in their early stages. Team valuations and revenue opportunities can also vary to the extremes, making it hard to get a handle on what’s market. Finally, many teams grew out of an underground gaming culture, so it’s common for player contracts, financial statements, vendor contracts and other documentation to raise questions during the due diligence process. An M&A attorney advising on an eSports investment should expect the unexpected, and be prepared to call in a range of specialists in areas such as employment, intellectual property, real estate and immigration.

Types of Teams

Teams vary in their size, focus, stability and notoriety, and consequently in their valuation. Some teams focus their efforts on a single game, such as Dota 2, CS:GO or League of Legends. These teams typically consist of 3 to 7 players, coaches and an administrative support staff. On the other hand, teams such as Fnatic, Evil Geniuses and Team SoloMid field multiple squads that compete in different games. Such diversification enhances the ability to generate revenue; however that comes at a cost, in terms of added infrastructure, employees and overhead.

Another key consideration is whether a team has a guaranteed slot in a major gaming competition, or whether it needs to buy one, or even compete for one through a promotion and relegation system. These slots are valuable for a number of reasons, including the fact that they provide significant branding and revenue generating possibilities. When teams with guaranteed slots become available, they usually attract intense interest and bidding. Recent sales have been reported in the seven-figure range, including the sale of Team Coast for a reported $1.4 million, and Gravity to former NBA star Rick Fox for $1 million.

Another option that exists is purchasing a franchise. Several eSports leagues are starting to emulate the business models of the NFL, NBA and other major leagues. For example, Riot Games, the publisher of League of Legends, recently announced that it would adopt a more traditional franchise and revenue sharing model. Under the new system, ten teams will become permanent franchises, at a reported cost of $10 million per franchise. Blizzard Entertainment has also indicated its desire to move its Overwatch League to a franchise system with city-based teams, at a reported franchise fee of $20 million.

Franchises typically provide owners with stability, a greater say in the league’s growth and operation, as well as a slice of the league’s revenue streams, including the lucrative media rights. Investors seeking to enter a franchise-based league will have to closely scrutinize the league regulations, the process for resolving disputes, the revenue sharing terms and the parties’ other key rights and responsibilities.

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