Don’t panic about Platinum Equity buying the Pistons with Tom Gores

Dan Primack of Fortune wrote a post that has scared many Pistons fans. A couple key excerpts:

Gores isn’t really going to be the next Detroit Pistons owner.

Go back to the press release, which was titled "Karen Davidson and Tom Gores Reach Agreement on Sale of Detroit Pistons." At the end of the first paragraph, you’ll notice that the sale actually is to "Tom Gores and his investment firm, Platinum Equity."

That’s right: The Detroit Pistons are about to become the first major professional sports franchise in North America to be owned by a private equity fund. Not by flesh-and-blood individuals who made their fortunes in private equity (like the Boston Celtics or Golden State Warriors), but by a $2.75 billion financial vehicle. What that means is that this the Pistons are about to become an investment, not a labor of love. Something bought for the purpose of later being sold, not to keep in the Michigan-loving family for generations.

The NBA is obviously aware of this reality – my understanding is that Platinum has fully explained to league officials how PE funds operate – and apparently is okay with it.

Gores may well still hold a candle for Bob Lanier, but his primary motivation (and fiduciary duty) today is to turn a profit. If that can be done by maximizing other assets acquired in the transaction — including the Auburn Hills arena, an outdoor concert venue and a music festival — while using the ball-club as a loss leader, then that may be what happens.

Even to a financial novice like myself, the article seemed like it was just inducing unnecessary fear. So, I asked a friend of mine who’s a business school graduate and a law school student what he made of Primack’s post. Here’s an edited version of what he said:

Does it being a private-equity firm matter? We don’t know without more information.

For instance, the amount of money the firm borrows to fund its purchase could change its operating strategy. A concern about private-equity firms is that, despite their names, they sometimes buy a company using the acquired company’s own assets to secure a large loan to fund the purchase. Borrowing money requires paying interest each year. The responsibility to pay interest means you must generate the cash flow needed to cover it each year. An over-leveraged firm may need to make short-term cuts to meet its debt payments. But debt is appropriate in many, if not most, circumstances–you’d be much more likely to find a company that borrows money than one that doesn’t.

This compares with an equity investment. This is what happens when you buy a stock. You are an owner entitled to any profits. The firm has no legal duty to generate a certain amount of profits for you each year. Owners, of course, will be unhappy (and perhaps sell their shares) if they aren’t earning an appropriate return on their investment, but the firm doesn’t have to generate a certain amount of profits each year.

Companies typically finance acquisitions through a combination of both. The mix of debt and equity will change in every situation. Without knowing more, we don’t really know how this will affect the team’s operating strategy, if at all.

Primack also notes that that the firm will have a fiduciary duty to its investors. They may be the only team owned by a private-equity firm (or maybe not), but they surely are not alone in having a fiduciary duty. Madison Square Garden, Inc., a publicly traded company, owns the Knicks. They without a doubt have a duty to investors. Other NBA teams may be owned by partnerships in which the operating partners have similar duties to the other partners.

Even if fiduciary duties do exist, we don’t know what this even means, as Primack points out. Winning might be the best way to maximize profits.

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