From the previous articles, we now know that sports franchises across the world are now being viewed as commercial entities. Hence, it is vital to derive the correct valuation for them in order to ensure that buy and sell as well as restructuring transactions can take place at the correct valuation.

However, we also know that the valuation of sports franchises is not an easy task. This is because there are various approaches that are used to determine the fair value of a sports franchise.

The income-based approach to valuation is one of the most commonly used approaches that helps determine the fair value of a sports franchise.

The method used to arrive at the valuation of a sports franchise using an income-based approach as well as the benefits and drawbacks of using this approach have been mentioned in this article.

The Method

The income-based approach which is used to value sports franchises is quite similar to the discounted cash flow valuation approach which is used to find the intrinsic value of companies across the world.

Even though the name suggests an income-based approach to valuation, here too, the cash flow is being calculated and is being used to value the company. The steps involved are as follows:

1. Forecast Revenues and Expenses: The first step is to find out the revenues as well as expenses that the sports franchise is likely to generate in the forthcoming years.

   Such forecasting is difficult since the revenues as well as expenses have a high degree of correlation with the performance of the team which can be quite difficult to predict. It needs to be understood that both cash as well as non-cash revenues and expenses are taken into account at this stage.

2. Forecast Taxes: The next step of the method is to try to predict the taxes that need to be paid to the government. In different parts of the world, sporting franchises are subject to different taxation rules. The calculations related to taxation also change year by year. Hence, it can be a tedious task to determine the exact cash flows.

3. Use an Appropriate Discount Rate: The last step of the process is to discount the future cash flows to find their present equivalent. The procedure to do so has been detailed in the discounted cash flow methodology. In order to do so, an appropriate discount rate that reflects the risks of investing in the sporting franchise must also be found.

Benefits of Using the Income Approach

The income approach is preferred by some sporting franchises since it has some advantages. Details related to some of these advantages are as follows:

1. Closest to Intrinsic Valuation: The discounted cash flow method for valuation is widely accepted by value investors worldwide as being the gold standard for determining the fair intrinsic value of any firm.

   Hence, if the value of a sporting franchise has been calculated using this method, it is very unlikely that the sporting franchise has been overvalued and purchased at a higher cost.

2. Valuation Comparable with Other Industries: The discounted cash flow method of valuation is the method that is used in various industries in different parts of the world. Hence, if the same methodology is used for evaluating sports franchises, then the valuation can be considered to be comparable to other industries. This provides additional legitimacy to the valuation amount which is derived using this method.

Disadvantages of Using the Income Approach

This method has been called out as being unsuitable for calculating the valuation of sports franchises by many critics. The main disadvantages of using this approach have been mentioned below and are as follows:

1. Does Not Take into Account Heavy Asset Base: The income-based approach or the cash flow-based approach only focuses on the cash flows that will be generated by the firm in the present as well as in the future. This approach does not take into consideration assets that are held by sporting franchises.

   There are many sporting franchises across the world who have ownership of control of assets which are several times greater than their own cash flow. In such cases, the income approach ends up undervaluing the firm since it does not take the asset base into account.

2. Does Not Take into Account Intangible Assets: Just like stadiums and other fixed assets, sporting franchises also have a lot of intangible assets. These could be related to the brand name, reputation, or player contracts that the franchise has.

   Just like fixed assets, these intangible assets are also not taken into account which creates an impression that the sporting franchise is being undervalued if this method is used.

3. Non-Financial Decision Making: An important point to be noted is that sporting franchises are often considered to be luxury goods or vanity purchases. This means that the laws of normal economics that apply to other purchases do not necessarily apply to these purchases.

   The valuation of sporting franchises is less about finance and more about greed, hubris, pride, and other such factors that cannot really be accounted for. This is the reason that the actual transaction prices at which sporting franchises are brought or sold vary significantly from the valuation derived using the income approach.

4. Information Not Freely Available: Last but not least, the income approach assumes that the company trying to value the sports franchise has detailed information available about the same.

   However, the information related to income, expenses, cash flows, and other details is not widely known. Hence, even though, theoretically, this is a great method to value a sports franchise, the practical difficulties faced when implementing this method make it unviable.

The fact of the matter is that even though the income-based approach is theoretically the most appropriate method that can be used for the valuation of sports franchises, it is hardly ever used.