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Completion Bonding for Interactive Title Development
by Bruce Poitevin
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Product
development has always been a risky game. Now it is becoming expensive,
too. In the last few years, the average cost to develop a new interactive
title has passed $1 million and continues to climb. Developers are rarely
in the position to finance a project with internal funds, and most publishers
are being squeezed by large budgets and reduced shelf space. Banks have
traditionally stayed away from financing product development, so the burden
has fallen almost entirely on the publishers. This has led to industry
consolidation, and a big problem for developers looking to find money
to make their next game. It is little wonder, then, that an alternative
method for financing new title development has created strong interest
in the industry.
The Structure for Completion Bonding
Most development is now undertaken using the "advance royalty" method
of financing. The publisher funds the developer on a milestone-to-milestone
basis until completion and the developer waits for its big payoff from
the much-anticipated stream of dollars coming from sales of the game.
Completion bonding provides an alternative. Adapted from the model long
used in the independent film business, completion bonding is paired with
bank lending to bring a new source of funds to the industry. The process
works like this: the developer and publisher sign a development agreement,
as they do now, stipulating a budget and delivery time. The bond company
issues a performance bond to both the bank and the publisher that guarantees
on-time and on-budget delivery. The bank then funds the developer directly
during the development period. Upon delivery of the accepted product,
the publisher pays off the bank loan.
The Advantages
Completion bonding brings several advantages to the developer. It puts
the developer on a more equal footing in its negotiations with the publisher.
This allows the developer to justify higher royalty rates and to present
a budget with room for contingencies and a reasonable profit. It gives
the developer greater creative control over the project, and it creates
a more stable payment stream as payments come from the bank, not the publisher.
In addition, it allows the "bonded" developer to stand out from its competitors
when approaching publishers for future projects.
Why would a publisher want to use this new financing vehicle? An obvious
reason is the guarantee of on-time and on-budget delivery. The publisher's
risk during title development is reduced almost to zero. It does not have
to pay until an acceptable product is delivered. And because the publisher
gets to keep its money until delivery, it gains a much higher return on
its investment than the advance royalty model. In addition, it allows
the publisher to match revenue and expenses in the same accounting period,
thus smoothing the earnings reports to stockholders and investors.
The advantages to the publishers are significant. This is why the developer
gains leverage when negotiating new deals. The completion bond model provides
a win-win solution.
How Does a Developer Qualify
One of the first questions we are asked by both developers and publishers
is how we qualify a developer. Given the widely reported problems with
late deliveries and frequent cost overruns, it is a very fair question.
In the interest of space, the process can be summarized as an intensive
review of three areas: the developer's background, history and experience;
the match of the team members with the technical and creative demands
of the title; and the management and organizational skills of the developer,
including financial condition. Developers are a diverse lot, and each
must be viewed on its own merits. A developer with experience in flight
sims may not be good at strategy games, so the due diligence process involves
quite a bit of subjective analysis.
The qualification process does require a fair amount of paperwork: business
plans, resumes, game design documents, technical design documents, etc.
For some developers, this is easy because they have all of these things
in place. For others, the request for due diligence items may provide
the impetus to adopt some business management ideas that can help the
business grow. Developers are usually very creative, innovative and independent,
but not always the best at running a business. The completion bonding
vehicle can provide a structure that helps a developer build a sustainable
business.
One of the most important steps to qualify a developer is to visit its
office and meet the principals and the team members. An on-site meeting
provides a way to understand the individuals behind the resumes, and to
see how the team works together. A successful game reflects the dedication
and spirit of those who work so long to put it together, and it is not
possible to appreciate these talents without talking face-to-face.
Disadvantages and Other Issues
The questions that often come right after how we qualify developers is
"how much does it cost", and "who pays for it?" Pricing depends on many
factors and will vary from one provider to another, but the range is from
12-16% of the costs of development. This covers the bond fee and the bank
charges, including interest. In most instances, the costs of the bond/bank
financing are added into the price paid by the publisher upon delivery
and are included in the bank loan. Therefore, the developer is not out
of pocket for the costs, but does not start earning royalties until the
costs are recouped by the publisher.
The completion bond is a guarantee that the developer will perform according
to the terms of the development agreement. The bonding company is liable
for payment to the bank or publisher should the developer fail to deliver,
and will protect against its exposure to loss in case of default and payment
of a claim by taking a security interest in the rights to the title and
in the assets of the developer. In short, the developer's assets are on
the line.
The rights of the bonding company are included here as a "disadvantage,"
but experience has proven this issue to serve an unexpected purpose. It
has motivated the developers to focus and plan more effectively, and to
encourage the staff to work hard to meet a goal that is of obvious importance
to the welfare of all team members. The bonding model supplies structure
to the development process.
The changes in the game industry have created the need for an alternative
financing method, and completion bonding is starting to gain favor. It
provides significant advantages to both developers and publishers, and
brings a needed structure to what has been a relatively unstructured world.
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