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Franchise

There is a subject, within the theme of competitive sports systems, that is possibly more familiar to the esports community than within the traditional sports world: the so-called franchise systems.

The origin of this model of organization of the competitive environment comes, obviously, from traditional sports, more specifically from the North American experience with baseball. At the end of the 19th century[1], some teams competing in this sport decided to join forces and create their own league, managed by themselves. This model was quite successful in the USA, as we see in the cases of the NBA, the NFL, the MLS, among other leagues set up as a franchise system[2]. However, in the rest of the world, most traditional sports competitions are not organized in this way, with the federative-associative system (and variations thereof) being the most adopted model.

Nevertheless, the franchise system had considerable adherence in the universe of esports, as we see in the examples of the Overwatch League and the League of Legends (LOL) regional leagues around the world (LCK, LCS, LEC, CBLOL, among others). The reason for choosing this model for some of the main esports leagues in the world is closely related to the dynamics of this industry, as will be further explained below.

Franchise system

So what is a franchise system? With due reservations when summarizing something so complex, we can consider that a sport (and an esport) franchise system is a model of organizing (e)sports competitions in which participants receive the right to operate a professional team of a certain (e)sport modality, within a league/competition managed by a centralizing entity. To organize it, a legal framework of agreements is celebrated between such competitors and eventual third parties.

In this scenario, the “franchises” are the teams themselves. To better illustrate the configuration of this system, we shall use some cases from traditional sports as examples.

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In the case of the NBA (National Basketball League), in a very brief approach, history shows that some basketball teams got together and, through partnership agreements and other legal instruments, created a kind of association to create and regulate a national basketball league[3]. In such agreements, with special emphasis on the NBA Constitution and By-Laws[4], signed between the teams, and the Collective Bargaining Agreement (CBA)[5], celebrated between the NBA and the league’s athletes’ association, a series of rules were established that govern not only the competitive aspects, but also the business environment surrounding the league, such as:

(i) the composition of the Board of Governors, as well as the voting system for decision-making in the NBA;

(ii) the criteria for selecting new teams (entry fee, territorial aspects, growth projection, business plan, etc.);

(iii) the revenue division system between participating teams and athletes;

(iv) the salary caps for the teams;

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(v) the system for recruiting new talents (draft), hiring and dismissing players with contracts in force, the free agency/agent system;

(vii) the Code of Conduct for managers, players, staff;

The NBA has a Council (Board of Governors) made up of representatives appointed by each of the teams participating in the league, who, in addition to electing the Commissioner (a kind of CEO of the entity, with broad powers — including those to resolve conflicts and apply penalties), will also be responsible for making important decisions for the competition and the league’s business. In other words, teams have a considerable degree of control in the administration of their tournament, something different from what is seen in federative-associative systems, for example.

The corporate design created to build a balanced competition is an aspect of this system that deserves special attention. The imposition of rules, through a sophisticated system of agreements (Constitution and By-Laws, CBA), which create, for example, limitations on athletes’ compensations and teams’ payroll (the Salary Cap), helps a lot in this technical leveling of competitors.

Nonetheless, even though this Salary Cap can be relaxed in certain situations, this franchise system provides for a penalty fee called Luxury Tax, which determines that teams that exceed the cap established must pay a fee equivalent to the exceeding amount (multiplied by some factors) for the NBA, which will apply it to league projects and/or pass it on to teams that have not reached the imposed limit.

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Likewise, the sharing of revenue between teams is another mechanism aimed at promoting this competitive balance — something that differs greatly from the federative-associative system. In addition to the amounts received directly by the NBA, which are divided among the teams, the entity adopted a sophisticated revenue sharing system, recently changed, so that each team delivers part of their individual earnings to a common fund — the revenue sharing pool. Thus, through complex contractual requirements and rules, the resources of this fund are divided between the league’s participants, according to certain criteria (performance in the championship, fan engagement, etc.).

Another difference of this system that is worth mentioning, is the creation of companies to manage common businesses. The NBA Properties, Inc., for example, negotiates the licensing of the brands of all teams, that is, organizations have given up negotiating individual licensing contracts for the exploitation of their brands in products through a single corporation.

Obviously, NBA teams maintain a certain autonomy, as player salaries are paid by such organizations, as well as the costs of their arenas and other operational expenses. Likewise, local broadcasting rights and sponsorships, along with ticket fees for watching the games are revenues negotiated and received directly by the teams.

And of course: in the NBA there is no relegation/promotion, something that is initially seen as an attack to sporting merit. However, from a business point of view, eliminating this risk means greater stability for teams, allowing better planning and even the option to invest in new talents, in addition to generating an attractive deal for investors and sponsors, that can avoid the risk of seeing their investments or the exposure of their brands collapsing with an eventual relegation of the team.

As we can see, this franchise system described above, implemented through contractual legal tools and solid governance structures, gives rise to a purpose of mutual growth among all competitors — this model clearly makes the competitors on the courts become partners in the business around it.

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Nonetheless, sports franchise systems have their nuances depending on the market and the interests of their partners. The MLS (Major League Soccer), for example, uses a corporate structure in which the league owns everything, including the teams (a single entity structure[6]). The “owners” of the teams, called investor-operators (IOs), become partners in MLS (Major League Soccer, LLC) and receive a share from the company that manages the league. These IOs, in turn, receive the right to operate a team (a franchise) in a given location, as decided by the plenary of MLS members/partners. In this case, therefore, the license comes from the MLS — this is the owner of the teams (the opposite of what is observed in the NBA).

Therefore, in traditional sports we can see that franchise systems are shaped around a basic concept (closed system, effective participation of teams in management and division of revenue, competitive balance), but gain particularities according to the sport and, obviously , to the interest of the league’s founders and shareholders.

Franchise system and esports

In esports, franchise systems also have certain particularities, not to say several. Without any exaggeration, we might even say that a new format of competitive organization emerges in this context, a model strongly shaped by a preponderant legal element in this industry: Intellectual Property (IP).

A game is a creation full of IP rights (copyrights, brands, software), which belong to the developer and/or publisher of that creation. The latter, in turn, holds the right to exclusively use the protected product, including the prerogative to prevent third parties from exploiting part or all of that creation, with small exceptions.

Therefore, for the creation and exploitation of any business that has a game as a central element, the authorization of the holder of its IP rights is essential — and an esports league organized under a franchise system is no exception. In other words, as a rule, any esport franchise system must have the participation or, at least, the authorization of the game developer/publisher.

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Given this, currently we see two main models of franchise systems within the esports’ industry — models that exist mainly due to the interests and policies of the holder of the IP rights of the game object of the competition. In the example of the regional League of Legends leagues (LCK, LCS, LEC, CBLOL), it was Riot Games, the holder of the rights to said game and a party directly involved with the main leagues and competitions in the scene, that decided to implement a franchise system in its tournaments[7].

To join this system, organizations needed to formulate proposals (with information from their business, fanbase numbers, financial projections, marketing projects, etc.) and, when approved, buy a slot in these championships[8]. The initial value of a slot varied from USD 1,000,000 to 10,000,000, depending on the region.

Still in this example of the franchise model established by Riot Games, at the beginning of the US league (the LCS), following the essence of traditional sport’s franchise system models, a revenue sharing system was established in which part of the league’s receivables would be shared between organizations, Riot Games and athletes[9].

As announced in the early days of the LCS, half of the revenue allocated to the teams was divided equally between them, while the other portion would be distributed proportionally to the fulfillment of certain criteria (performance in the previous split, fan engagement, product sales, etc.). This shared revenue is made up of the values ​​of broadcasting rights, sponsorship and product sales received by Riot, as well as a portion of each team’s individual revenue (forming a revenue prize pool, as seen in the NBA). Expenses with salaries, staff and other operational costs are the responsibility of the organizations. In this example from the US LoL league, Riot also established a minimum compensation rule for athletes[10].

In view of this, it is necessary to highlight a central point in the esports franchise systems: if the IP rights already grant publishers considerable power over the competitions that use their games, the creation of a corporate legal structure, which creates contractual obligations between organizations and publisher, further reinforces this control by the owner of the game’s IP rights.

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Although contracts signed within the LCS are not publicly accessible, some events and news indicate that, in fact, Riot maintains considerable control over the league’s decisions. In 2018, there was an incident involving one of the LCS teams, Echo Fox[11], in which one of its partners allegedly promoted some negative actions and, as a result, Riot determined that said organization should expel him from the company’s shareholders or sell their LCS spot to another team, otherwise the team would be expelled from the league and their spot auctioned.

In this example, we can see that the franchise system concept we have from traditional sports (whose control is in the hands of competing teams) can be very far from what we observe in the context of esports. This will invariably depend on the behavior of the one who holds the IP rights related to the game.

On the other side of franchise systems in esports, we have the case of the Campeonato Brasileiro de Counter Strike (CBCS), an entity that was effectively formed by the competing organizations without the participation of Valve, the game’s publisher.

Valve is well known in the esports scene for adopting a more open policy in relation to tournament organizing, granting a free license to those interested in exploiting competitions with its games, subject to a few rules of conduct and a permission for Valve to use the content generated with the event[12]. Therefore, this allows esports franchise systems to be designed in a similar structure as observed in the NBA and MLS examples. Nevertheless Valve still has the right to, at any time, revoke the license granted in view of its IP rights ownership.

The CBCS, therefore, was born as an esports league that adopted the franchise system model, but without the centralization of power in the hands of the publisher. According to information published at the time of its creation[13], the CBCS’ organizations formed a private association (Aliança Brasileira de CS:GO — ABCS), that would act as the league’s council and define the obligations and rules applicable to the competition and its competitors.

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Therefore, in the example of the CBCS, we can see a franchise system closer to the experience of traditional sports, that is: a league in which the teams have true influence in matters related to the championship and its related businesses, without interference from the publisher.

However, despite Valve’s open approach, as the IP owner it will always have strong influence and, ultimately, the final say regarding the exploitation of its games. In a very emblematic case in relation to this publisher’s style, recently Valve issued a statement recalling that it grants free licenses for purposes of tournament organization, but that it does not agree with tournaments that require exclusivity from their participants[14]. This might deeply affect the creation of franchise systems based on Valve’s games.

Therefore, as we can see, the franchise system is a model explored in the competitive organization of esports, but with its own particularities, especially due to the nature of this industry that is heavily built around an IP framework. As previously seen, this is a format that usually generates a more balanced competitive environment, but mainly a more prolific business space for franchise owners.

On the other hand, it is worth mentioning that there are criticisms regarding this model, such as the barriers for new organizations to reach the elite of their modality (creating a certain disincentive to the competitive environment), restrictions on free negotiation of compensation with athletes (which could represent a violation of labor and antitrust precepts) and the possible change of focus from sporting merit to revenue generation as the main guideline of this model.

As seen in this text, the franchise system allows exploring different legal and business arrangements to create a more sustainable and collaborative environment (for competition and business purposes), but it is still full of challenges, especially in the young industry of esports.

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[1]Wladimir Andreff ‘Origins and Developments of Sports Systems’, The SAGE Handbook of Sports Economics (December, 2020), 8-9, available at <https://www.researchgate.net/publication/346679981_Origins_and_Developments_of_Sports_Systems> access on 20 March, 2024.

[2] Ibid, 9-10.

[3] Ibid, 8-9.

[4] Available at <https://ak-static.cms.nba.com/wp-content/uploads/sites/4/2019/09/NBA-Constitution-By-Laws-September-2019-1.pdf> access on 20 March, 2024.

[5] Available at <https://imgix.cosmicjs.com/25da5eb0-15eb-11ee-b5b3-fbd321202bdf-Final-2023-NBA-Collective-Bargaining-Agreement-6-28-23.pdf> access on 20 Martch, 2024.

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[6] Willian Reade, ‘Major League Soccer Single Entity Structure’ (2019) available at <https://lexsportiva.blog/2019/10/09/mls/> access on 20 March, 2024.

[7] Available at <https://www.riotgames.com/en/news/building-the-future-of-sport-at-riot-games> access on 20 March, 2024.

[8] Available at <https://nexus.leagueoflegends.com/en-us/2017/01/evolution-of-the-na-lcs-2/> access on 20 March, 2024.

[9] Ibid.

[10] Ibid.

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[11] Available at <https://www.espn.com/esports/story/_/id/27822082/echo-fox-lcs-slot-sale-funds-305-million-distributed-court> access on 20 March, 2024.

[12] Available at <https://store.steampowered.com/tourney/limited_license> access on 20 March, 2024.

[13] Available at <https://www.terra.com.br/gameon/confira-todas-as-equipes-do-campeonato-brasileiro-de-csgo,da58a061271737669e35db04088d0290rd2tq92o.html#:~:text=O%20CBCS%20foi%20criado%20nos,League%20of%20Legends%20European%20Championship)> access on 20 March, 2024.

[14] Available at <https://blog.counter-strike.net/index.php/2019/09/25557/> access on 20 March, 2024.

Author

  • André de Oliveira Schenini Moreira

    André is a Brazilian lawyer with a Master’s Degree in International Law and is the managing partner at Feoli e Moreira Advogados, a law firm specializing in the tech and creative industries. With distinguished experience in Intellectual Property, Corporate, and Entertainment Law, garnered through his professional journey in corporate law firms and as a legal director at Grêmio FBPA (2009-10), André is renowned for his expertise in transactions and litigation pertaining to the gaming and esports markets. He is a member of the Esports Bar Association (EBA) and the International Game Developers Association (IGDA). Additionally, he serves as an advisor to esports organizations in Brazil and Latin America (ISURUS, INTZ, Redemption), and is a founding partner at Skillcore, a gamification startup. André volunteers as a mentor in entrepreneurship programs and entities (ACE, Global Games Pitch, MIT Hack Brazil), and regularly speaks and writes on legal issues concerning esports and gaming.

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