Five Things to Consider Before Starting Your DFS Company

March 20, 2020  |  By Blake Hart

Here at Vela Wood, arguably one of our most exciting practice areas is Daily Fantasy Sports (“DFS”). Call it bias by personal interest, but there is something universally sexy about an industry fitting the bill as Vegas meets Hollywood meets SuperBowl Sunday. We are seeing the entrepreneurial impact of this rapidly developing sect of our digital economy firsthand.

What comes as a surprise to many is that DFS has actually been around since the 1960s. Nonetheless, it was not until recently that the United States began experiencing widespread legalization, which has spread like wildfire across the country. What should not come as a surprise is how the legalization and ultimate commercialization of the industry enjoyed by millions is turning into a multibillion-dollar machine.

Have a great idea for the next big thing in fantasy sports? There are a few things you should know before diving in head-first. Dipping a toe in the murky waters of DFS can be intimidating, even for the most cavalier of entrepreneurs. Otherwise straight-forward topics such as formation, payment processing, state-by-state operations, and technology development are slightly complicated because of an inherent closeness to sports gambling. The following sections provide a glimpse into specific caveats to consider when bringing your daily fantasy game to life.

Gambling vs. DFS (and “Reasoned Legal Opinions”)

First things first—you will need to flesh out your game play and ensure it does not cross the line into sports gambling. A few years behind fantasy sports in terms of state-level legalization and overall acceptance, sports gambling businesses are far more expensive, time consuming, and challenging (if not downright impossible), to start up. This is generally the result of mandatory high-priced state authorizations, particularly in light of the limited licenses. It is of utmost importance to distinguish your game as DFS—but fear not, we are here to help you with that.

States are not the only entities interested in distinguishing between DFS and sports gambling. *Enter the necessary evil of payment processing.* To collect money from customers, you will need to secure a payment processor (or many – one for credit cards, one for ACH, one for online payments…and of course you will want a handful of backups in each category). Everyone knows that every payment processor will require a written legal opinion stating the game is DFS rather than gambling—and everyone knows that this legal opinion takes at least a month to draft. (Just kidding, nobody knows that—that’s why we’re here). Because this determination is necessary, timely, and of great importance, one of the first things we do is work through our DFS client’s gameplay and begin drafting the legal opinion.

Far more than a simple stamp of approval, this fifty-plus page document sets out the relevant laws, describes the gameplay, and provides a state-by-state analysis as to how the law in each state applies to the particular game. Significant time and effort go into each opinion letter, so we suggest starting as early as possible to prevent any holdups. The document may also be used as a roadmap to which states the game at issue may enter, and what additional steps are required.

Formation

When starting a business of any kind, it is generally wise to form an entity. Do you prefer a Delaware corporation, a Texas limited liability company (LLC), or maybe an S-corporation? Location of founders might influence where an entity is ultimately formed, and taxation and liability thresholds often weigh into the type of entity the founders choose. For DFS clients, an additional formation consideration is whether DFS is legal in the desired state of formation.

In addition to formation, you may need to register as a foreign entity and file fictitious name certificates in states with regulations that require you to do so.

Payment Processing

Payment processing for DFS clients has proven to be a huge pain in the ankle. As “high risk” merchants, DFS operators are subjected to an intense vetting process and are offered elevated rates and unfavorable contract terms with little to no bargaining power. It is unfortunate, but this is industry standard and something DFS operators have learned to accept as the cost of collecting payments from customers.

It is impossible to eliminate the headache of payment processing, but my unsolicited advice for minimizing the pain is: (1) seek out payment processors with DFS processing experience, (2) get started with the onboarding process as early as possible and expect delays, (3) secure as many payment processor approvals as possible, and (4) be patient. This process takes months and it is not uncommon for payment processors to fall through, even after going live. Therefore, being prepared with multiple processors can help you dodge a very expensive and potentially fatal interruption in business operations.

Development

Ahhh the fun part—bringing your idea to life. Some founders come with a team of developers, and others just an idea. Either way, much more goes into DFS technology development than the typical website or application. Here are a few unique considerations:

First, you will need to consider the cost and permissions required for your particular game. Where will you get the data you need for your contests? How will it be integrated? Will you use team or league logos or pictures of athletes? Whom will you need permission from to do so? This is yet another costly and time-consuming process, but the last thing you want to do is deal with an intellectual property or service provider dispute after your game goes live. The best route to prevention here is adequate preparation. Get your intellectual property ducks in a row and test out service providers before you launch.

Another unique DFS development consideration is timing. Are you banking on having your game up and running by March Madness or MLB’s opening day? If so, you will want to set milestones accordingly. Preparing for setbacks is not unique to the DFS industry, but the stakes of on-time delivery are much higher when considering the significance of events with hard deadlines and finite dates. Give yourself a cushion—and once you feel good about that cushion, give your cushion a cushion.

Finally, be prepared to integrate a number of compliance related and geo-fencing mechanisms into your platform. Payment processors as well as state authorities all have something to say about compliance, and you will need to block off access in some areas due to inconsistent state legality. By-the-book compliance here is important, but it is not impossible. Luckily for you, specialized service providers are more than adequately prepared to handle this and understand industry specific requirements.

State Licensing and Compliance

Our online tracker illustrates the state-by-state variance in DFS legislation. In the majority of states, DFS is widely accepted as legal, however, treatment within each state widely differs. Some states do not require licensing or registration—allowing DFS operators to freely operate within state borders, but others have a range of unique application processes and stringent fees for businesses offering DFS games to instate residents.

You thought payment processing was stressful? Welcome to the ultimate test of patience: state licensing and registration. The process is grueling, but there are a few tips I would like to offer to ease the pain. You can thank me later. The overwhelming secret to success here (and more importantly, to maintaining sanity) is organization. The following two organizational tips will keep you on track and significantly speed up the process.

First, make a list of all of the states requiring licensing or registration. This might sound intense, but you can simply pull it from your legal opinion letter. Here you will keep track of how much the application fee is, whether it is refundable, whether a DBA or foreign filing is required, if you need to pay an additional fee once approved, how in-state taxes are assessed, whether a background check is required, what the local market size is, and so on. Even states with the most straightforward application process will take you a couple of weeks. The list will help you determine which states are worth entering, and from there you can organize an order of attack.

Organization tip number two: keep the payment processing document packet tucked away in an easy-to-access location, because this is the foundation of every state application. All the excitement comes with the variance between additional documents required. Some—albeit not many—state applications are only a few pages long. More likely you will be met with a thirty to fifty-page application, an equal number of accompanying documents (each of which requires state specific naming conventions), requests for criminal background checks on everyone from your CEO to your secretary’s mother, and a fee anywhere from $100 to $100,000. Read each document carefully. It would be a shame to delay the process another month because you used black rather than blue ink.

My final two cents on this topic: utilize the state agent in charge of approvals. Have questions? Give the licensing office a call—everyone is extremely accessible and helpful. You can likely find the direct number to the person in charge on each state application, so there is no excuse to go in guessing. Submitting packets with lingering uncertainties only leads to unnecessary delays.

The good news? While daunting, state applications are optional. If you do not want to mess with the paperwork, then you can choose not to enter the state. Develop a realistic growth strategy that considers company resources available and the potential upside to entry based on the size of the market in each additional region.

So are you ready to take on the challenge and give DraftKings and FanDuel a run for their money?

This relatively novel area of entertainment has cleared a vein for a new wave of entrepreneurs. Whether you are a jock, a businessman, or you simply enjoy cracking open a cold one on Sunday and enjoying a little smack talk with your friends, DFS has created a marketplace turning historical hobbies into cold hard cash. This is true for the entrepreneur and the player alike.

Have a great idea for the next big thing in fantasy sports? We are here to help. I assure you, there is no time like the present.

About the Author(s)

Blake Hart

Blake is a senior attorney at Vela Wood. She focuses her practice on contract drafting, review, and negotiation on behalf of sports and entertainment individuals and enterprises.

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