Last week, The New York Times ran an article which stated that equity for endorsement agreements are gaining in favor with celebrities due to the recent explosion of the start-up scene, especially in California, and the deal's ability to create substantial income should the company become successful. This is especially true for professional athletes.
Professional athletes have particularly taken to equity for endorsement agreements. This is likely due to the potential of receiving a windfall and the players' understanding that athletic careers can be lost at any time. In recent years, several athletes have made headlines by entering into equity agreements. One of the most notable equity for endorsement agreements was David Wright's acquisition of .5% of Glaceau, the creator of Vitamin Water. When Glaceau was bought in 2007 by Coca Cola for $4.1 Billion, Wright's .5% was worth an estimated $20 Million. In 2010, Tom Brady entered into an equity deal with Under Armour, a now ubiquitous athletic apparel company. Most recently, in June, 2014, Richard Sherman entered into an equity for endorsement agreement with BODYARMOR SuperDrink.
However, accepting equity for endorsements has significant benefits and disadvantages for the endorsing athlete.
- Wealth building- Athletes have short playing careers and therefore have a short period of time to maximize their profits by capitalizing on their on-field success. Equity for endorsement agreements while the athlete is still playing can provide substantial income even after the athlete's playing days have ended.
- Favorable tax treatment- Standard endorsement agreements for cash are taxed as income. However, equity for endorsement agreements are taxed as capital gains, which is generally a much lower rate than income tax, when the endorser sells the stock.
- Potential windfall- As with David Wright, there is always the potential that the equity for endorsement agreement could result in an extremely large payday for the endorser. Of course, there are many factors involved in such an occurrence, most of which have nothing to do with the endorser. Researching the company and examining its financials (if possible) should allow the athlete a better prediction of the company's success.
- Risk of investment- There is no question that any investment involves some level of risk, and that many athletes' financial investments have previously led them to financial ruin. However, equity for endorsement agreements carry a fairly low level of financial risk because the athlete would not be investing money. Instead, the athlete is only investing the time necessary for the required appearances and commercials. Therefore, even if the company folds, the athlete would be in the same financial position as he started. The low risk-high reward potential of endorsement for equity agreements is a substantial benefit to the athlete.
- Delayed payment- Equity agreements may not be suitable for athletes who aren't financially stable or otherwise require immediate payment. These agreements can require that the endorser hold the stock for a period of time (several years) before it can be sold, thus delaying when the endorser can receive money for their endorsement.
- Stocks are subject to division at divorce- In many states, stocks acquired during a marriage are considered community property, or are otherwise subject to distribution upon a divorce. Therefore, a portion of any equity in a company gained during marriage can be lost through divorce. Of course, this may not be a problem if a prenuptial or postnuptial agreement is in place. By contrast, a standard endorsement agreement for money raises the endorsers income, which could have other effects within a divorce proceeding, but does not directly alter property distribution.
- Risk of investment- Although the risk of investment can be partially mitigated through careful planning and research, it must be noted that there is a chance that the company can fold, leaving the endorser with nothing. This does not leave the endorser in any worse of a position than prior to the endorsement, but ultimately receiving nothing for the endorsements is certainly a disadvantage that must be weighed.
- Being tied to the company- Equity agreements associate the endorsing athlete with the company for better or worse. These agreements can require a vesting period of several years, with little means of canceling the contract (unless a reverse morals clause is present) should the company or its founder do or say something which damages the business and its reputation. Potentially, the damage to the business' reputation can hurt the endorsing athlete's established brand through their association.
Although athletes and celebrities may be agreeable to equity for endorsements due to the low risk/high reward potential, companies do not freely offer such opportunity. Many companies are protective of their equity, and within good reason. My next post will discuss the benefits and disadvantages of equity agreements to companies, who bear a much bigger risk when offering equity for endorsements.