Posts filed under “Apprenticed Investor”

Congratulations! You just signed a $325 million deal. Now what?

Congratulations! You just signed a $325 million deal. Now what?
Barry Ritholtz
Washington Post November 23, 2014

 

 

 

Last week, we learned that Giancarlo Stanton signed an enormous contract: a 13-year, $325 million deal with the Miami Marlins. Before the 25-year-old slugger starts to celebrate, there are quite a few things he needs to think about, at least if he wants to enjoy the fruits of this contract’s bounty for years to come. He’ll need to take specific steps to avoid the fate of so many other professional athletes.

There are lessons in this for all of us — even if we don’t garner nine-figure compensation.

Let’s start with a simple truism: In sports deals, the numbers are never what they seem. Hence, after a lot of costs are factored, $325 million isn’t nearly $325 million. Before we drill down to the specifics of his contract, let’s discuss athletic contracts generally: The numbers look much bigger than they are.

Assuming Stanton actually is paid the full 13-year contract of $325 large — a big if — he will see less than half of it. He gets even less on a percentage basis in the early years of his deal — about 30 percent. Uncle Sam will take almost 40 percent off the top in taxes. Florida has no state income tax, so he saves on home games; however, the “Jock Tax” on away games will still take a bite. It’s been estimated the Jock Tax cost Alex Rodriguez $520,000 a year on a contract that was $70 million less than Stanton’s.

His agent will take 5 to 10 percent, as might his business manager. Then there are the lawyers, accountants, trainers, nutritionists, travel costs and all of those courtesy tickets for friends and family. It all reduces the net income.

So it sounds like a huge number — but in the real world over 13 years, the take home is probably about $10 million annually. That’s not peanuts, but it’s also not hundreds of millions of dollars. Even among the elite 1 percent in sports, there are budget constraints and limitations to spending.

Recall our earlier discussion of athletes’ finances this year. (Congratulations, you were drafted! Prepare to go broke.) I noted the dirty little secret of the sports industry:

“Professional athletes have been going bankrupt with alarming regularity for decades. . . . Shortly after they retire, nearly four of five NFL players are bankrupt or under financial stress, according to Sports Illustrated. . . . It’s marginally better in the National Basketball Association, where after retirement nearly two of three players are broke within five years.”

To avoid that fate, Stanton need only do a few things right and avoid the common errors. Before we get to that, let’s drill into the specifics of his contract. That $10 million a year we discussed was an average across the 13 years. In actuality, the contract is “backloaded” — meaning, the richest payouts are in the latter years. According to ESPN, “Stanton’s salaries over those first three seasons will be “only” $6.5 million in 2015, $9 million in 2016 and $14.5 million in 2017.”

So in actuality, Stanton will likely take home about $2.2 million, $3.1 million and $4.9 million over the next three seasons. Objectively, that is still a lot of income, but it sure is a lot less than the $325 million the headlines are trumpeting.

The differences between the headline and take home number is what gets so many young athletes in a fix. If they maintain a lifestyle based on those giant gushing news stories, they are headed for financial trouble. Spending money you don’t have in anticipation of salary that never arrives is the formula for ruin.

What is the smart thing for an athlete like Stanton to do?

It seems ridiculous to say that a guy with a nearly-half-a-billion-dollar contract needs to budget, but it’s true.

The prudent thing to do is to live as if you are only going to make the lowest possible income level in each contract year. As he garners more income from endorsements, performance bonuses and the higher payouts as the years progress, he should feel free to increase his spending — if that’s what he wants. The athletes who go broke are often the ones who spend money before it comes in.

His guaranteed income for the first five years certainly allows him to spend a few dollars. He can go a little bit crazy if he likes: buy a nice house, pick up an exotic car or two, send mama on vacation where ever she wants to go — and get her whatever she wants for Christmas.

But the right way to do any of that is to understand your cash flow. Knowing the guaranteed dollar amount for the first part of the contract and calculating your net take home pay is key.

Second, he needs to build his own team of professionals. Over the course of his career, he will need several good lawyers. He’ll eventually need a lawyer to draw up a prenuptial agreement. There is a huge overlap between the players who go broke and those who got married without a pre-nup. That is not a coincidence.

 

Baseball contracts worth $200 million or more

team years total average per year
Giancarlo Stanton Miami 2015-27 $325m   $25.0m
Miguel Cabrera Detroit 2014-23 $292m   $29.2m
Alex Rodriguez N.Y. Yankees 2008-17 $275m   $27.5m
Alex Rodriguez Texas-N.Y. Yankees 2001-10 $252m   $25.2m
Joey Votto Cincinnati 2012-23 $251.5m   $21.0m
Albert Pujols L.A. Angels 2012-21 $240m   $24.0m
Robinson Cano Seattle 2014-23 $240m   $24.0m
Clayton Kershaw L.A. Dodgers 2014-20 $215m   $30.7m
Prince Fielder Detroit-Texas 2012-20 $214m   $23.8m

 

Source: Figures were obtained by the Associated Press from player and management sources and include all guaranteed income but not income from potential incentive bonuses. There is no distinction for deferred money.

 

Also on the team: A good accountant is a must. An estate lawyer will make sure his money goes where he wants and not to Uncle Sam when he is playing in the celestial outfield. A fee-only (not commission) insurance agent is important, as is a good financial planner and a business manager. Watch the costs for each member of the team — they are there to save, not cost, you money.

I cannot overemphasize the importance of choosing members of your team carefully. Look for people who have a long track record and have been vetted by others before giving over even a little control of your wealth. As Jack Johnson of the Columbus Blue Jackets unfortunately learned, even someone as close to you as your parents may not be trustworthy. (Johnson is filing for bankruptcy after his parents allegedly stole $15 million from him).

Third, he needs to avoid all of the long-lost friends and distant relatives who seem to find newly wealthy athletes. Learn to say “My money guy handles that.” You are neither an angel nor venture investor. Have all of the hare-brained schemes and crazy ideas sent to them. After a respectful amount of time has gone by, a polite letter on official stationery will explain why “We are going to pass on this, but thank you for submitting your business plan, and please stay in touch.” It has become a cliché how much money newly wealthy athletes lose this way.

Finally, he should think about creating a smart long-term plan. This should include investing enough money to live on after his baseball career ends. He may only be 25, but he should also start to think about tax planning, an estate plan and whether he wants to establish a charitable foundation.

His plans and his risk tolerance will determine what his portfolio will look like. A conservative laddered muni bond portfolio can throw off 3 to 4 percent tax-free income for life. A traditional 60/40 mix of stocks and bonds should, over decades, yield about 6 percent. A more aggressive mix containing more small cap value stocks and emerging markets will generate higher returns — about 8 percent — but with greater risk and more volatility. All of these can be constructed using low-cost ETFs and other asset allocation tools we have discussed in this column.

The right portfolio mix will reflect his goals. If he is smart, and just a little lucky, he can see his net worth add up to hundreds of millions of dollars before his professional career ends.

Lastly, he needs to stay healthy — so he can keep playing and fulfilling the obligations of his contract.

In sum:

 Get the I’m-rich-I-want-to-do-a-little-crazy-spending out of your system.

Understand your own finances.

Figure out your lifestyle before you start spending.

Make a long-term financial plan.

Figure out your financial goals and targets.

Get a good estate-planning attorney (and a matrimonial attorney, too!)

Find a fee-only insurance agent.

Run your financial life like a business.

Stay healthy.

 

 

~~~

Ritholtz is chairman and chief investment officer of Ritholtz Wealth Management. He is the author of “Bailout Nation” and runs a finance blog, the Big Picture. On Twitter: @Ritholtz.

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