Book Excerpt: Tips on negotiating key legal agreements in games
The following excerpt, a chapter from "Video Game Law: Everything You Need to Know about Legal and Business Issues in the Game Industry" by S. Gregory Boyd, Brian Pyne, and Sean F. Kane, may provide devs some interesting insight into how to negotiate. The book was published in June, and is available for order on Amazon or directly from publisher CRC Press.
What does it really mean to "negotiate"?
Whenever one person talks to another about a deal, there are a lot of moving parts.
How experienced are both people in buying or selling this item or service? How clever are the parties involved? How well do the parties understand the rules and strategies of negotiation? Last and most important, how much does each party want to do the deal?
The first three questions are fairly self-explanatory. Experienced, bright people who know negotiation strategies are pretty obviously going to perform better than people who do not have those tools.
The fourth element above—“how much does each party want the deal”—is more complicated. To begin to unpack that question, negotiation studies have created a term called BATNA.
BATNA stands for Best Alternative to Negotiated Agreement. Consider buying apples at the local farmers’ market. You can walk up and down the lanes, looking at the apples in the different stands. You can judge the quality of the apples and then compare the prices. If you think a stand is too expensive, you do not have to buy from it. If one stand is very cheap, but the apples are rotten, you do not have to buy from it either. You have a lot of choices at the farmers’ market. When you are at one apple stand, your BATNA is to walk to the next stand.
"Write down the 'walk-away' point prior to going into the negotiation because it is so easy to get caught up in the discussion and fall in love with the deal."
Contrast that experience with hiring a superstar CEO or landing a big publishing agreement. There are not that many superstar CEOs out there. There are not that many publishers interested in each game (for most developers). You have to be more careful with those negotiations than you are at the farmers market. Your BATNA is worse if the deal falls through.
Put another way, supply and demand alters negotiation power.
Strategy and planning: Walking away
Know your goals going into any negotiation. Do we have to get at least 3 million dollars for the development of this mobile game? Do we prefer to pay the CEO less than $250,000 as a base salary and not give up more than 3 percent of equity in the company? All other things being equal, the party that knows what they want going into a negotiation will do better than one that does not know what they want.
One goal that should always be considered is the “walk-away” point. If the CEO asks for more than a $250,000 base, we will have to move to the next candidate. If we cannot get at least 3 million dollars, we cannot develop the game to our standards. If the film company will not indemnify us for the movie IP, it is too risky to make the game because we may get into litigation.
You should write down the “walk-away” point prior to going into the negotiation because it is so easy to get caught up in the discussion and fall in love with the deal. After the agreement is signed, it is very difficult to back out.
Is it best to be compromising or aggressive? Anyone that answers this question with one answer or the other is wrong. Anyone that has just one style is going to fail in negotiation at least half of the time. The different postures are just tools. Sometimes you need a hammer and other times you need a saw. One cannot be substituted for the other.
Normally, it's best to start out nice and compromising and only move to an aggressive position if forced to do so. Compromisers respond well to other compromisers, as do some aggressive people, as long as they are still perceiving progress toward their goals. Aggression is useful when another aggressive negotiator refuses to respond to a compromising posture, or when you need to force a final position from a compromiser. Aggression can also be useful when the other side is obviously in the wrong and is offering an off-market position: surely, Disney, you are not saying that we have to continue working if you are not paying us.
Remember, you can always go from nice to aggressive, but it is very difficult to go the other way. People remember when someone is aggressive, especially if it includes a personal affront. People take insults personally. But true insults are rare. The more common problem is implying something that people take personally.
The most common example is a party stating or implying they know more about an industry or have more experience in a negotiation subject. Something as simple as saying that a definition/section/price term is standard in the game industry really says that the person speaking knows a basic piece of industry knowledge and the other side does not.
This pushes on the other side’s insecurities and may create a personal affront. Normally, it is not even a true statement. Retreating to a “standard” argument is a refuge for the ignorant and weak in this author’s experience. Very few things are standard. When they are, every person in the negotiation knows it and it does not need to be said.
Saying something is standard is an aggressive negotiation tactic designed to establish an experiential superiority and shame the other side into accepting the deal. The right answer to that tactic is to say that, “even if it is standard, it will not work in this deal because…” That rejoinder does not admit that the position is standard while simultaneously showing that you will not fall for that tactic.
Diagnosing a problem
When people do not agree or appear not to agree, your first thought should be to ask “why?” “Why?” is the key to diagnosing a problem and figuring a way through it. The next step is to ask more questions. A good second question is “can you tell me more about that?”
Often people will literally explain the way through a problem just by answering those two questions. Do you really disagree on ownership of the final product or do you really just disagree on control of the distribution of the product? Do you really disagree on price, or is it perhaps just the upfront development pricing, and can the difference be made up in the royalty?
This distinction is key because a perceived disagreement can often be resolved through questioning and subsequent drafting. Compare this with an actual disagreement—which can only be resolved by one company giving ground to the other.
Good business development vs. bad business development
After you ask “why?” and “can you tell me more?”, you will learn whether the issue can be addressed in the drafting or whether it is an actual difference of opinion. This is a core distinction when working with attorneys.
Attorneys can make suggestions and help you to ask questions. They can help you sort out something that needs to be discussed more from items where there is real disagreement. They can also draft language when you agree on the details of how you want something to work in practice. They can negotiate on behalf of the company, if they are empowered to do so. All negotiations are easier if everyone agrees about when a deal is ready to go to contract. The majority of deals that do not close were not ready to go to contract. The parties do not really agree on fundamental issues and drafting starts too soon.
"Make certain that the key elements of the deal are worked out prior to moving to contract writing. If you fully negotiate the elements summarized below, you dramatically increase the chances of a successful negotiation."
How do we avoid that outcome? Make certain that the key elements of the deal are worked out prior to moving to contract writing. If you fully negotiate the elements summarized below, you dramatically increase the chances of a successful negotiation.
Conversely, failing to work through the items below prior to documenting the deal is a failure of business development. We want to avoid what would qualify as bad business development. When I see this, I often refer to it as used-car business development, because that is the skill displayed. It looks like this: we have some idea on price and some idea on what we are buying, and then we are told “now go paper this.”
That is a hand grenade of molten shit, not a real deal. And yet, this problem is much more common than it should be. We avoid it by working through the seven core items below.
Intellectual property, term, termination, indemnity, price, payment, net revenue
These items are important in almost every deal in the game industry. Licenses, publisher agreements, and even employment agreements can touch these items.
- Price: What is the price for this deal and how is it paid? Is it spread out, up front, or on the back-end? Does it require invoicing prior to the payment or is the payment just made?
- Term and termination: How long does the deal run for? Can it be extended? How can it be terminated? Is the termination for breach alone or can it be for convenience as well? In the event of termination, what is paid out and when?
- Ownership: Who is going to own what is made under the agreement? Does it make a difference how it is developed? Is there a license back? If there is a game, who will make sequels?
- Indemnity: Indemnity is about who covers any third-party damages related to an agreement. What if there is a privacy or other regulatory violation? Or an infringement of third-party intellectual property? Who pays? Indemnity is like children at a party. If your child breaks something, you pay for it. If someone else’s kid breaks something, they pay for it. In deals, the question is: Whose kids are whose? Who covers what in a transaction?
Show me the money
They say that possession is nine-tenths of the law. Whenever possible, on either side of an agreement, try to be the person that receives the money directly. Historically, in the publisher–developer context, the publisher always received the money from distributors. Modern distribution through platforms like iTunes and Steam has changed this. Now, it is possible for games to be distributed through the developer’s account. In those cases, the publisher receives the royalty split from the developer.
In theory, this should not matter, but in practice it matters a great deal. The party that receives the money first controls how deductions are made and has the initial view of critical sales data.
In a dispute between the parties, the first thing that happens is all payments are suspended and are usually held in escrow. Holding the money is key in a dispute. Refunds outside of a litigation are rare, so people tend to hold on to revenue until a settlement is reached. Payments are the lifeblood of both companies, but especially to the developer. The company that is holding game revenue is in a much more powerful negotiating position.
After you have done dozens of agreements of a particular type, there is an inclination to omit initial negotiations and skip to the end. You have a pretty good idea of how it is going to work out and you might want to just draft the agreement to that point and hold it there.
This is a mistake. A colleague once told me that you “have to dance the dance.” Rationally, this does not make the most sense. But there is something about going through the process that people find satisfying. There is an educational element for both parties: issues are fully explored, and people get comfortable working together. As a result, pushing for a consensus draft right away usually results in failure and the party that proposes it often loses more ground than they should. The other party still wants to “dance the dance” and press for more concessions.
Deal pace and process
Two commonly discussed terms around the pace of a negotiation are deal fatigue and deal momentum. Depending on corporate needs and the size of a transaction, a deal may take a few days to several months. During that time, be aware of both of these concepts. They are psychological, not legal, but they have huge effects.
Deal fatigue is when one side appears to lose interest in the deal and may actually lose interest in the deal—not because it has suddenly become a bad deal—but because they are tired of negotiating it. Deal fatigue manifests itself in two ways. First, in some cases, people cancel the deal or genuinely lose interest in it. They say the opposing party is “too difficult to work with” as a reason to stop negotiating. This is not helpful to the negotiation. Deal fatigue can also take the form of people giving up points they should not have, or drafting quickly (and sloppily) just to tick an issue off the box.
Deal momentum is the idea that frequent drafts, emails, meetings, and calls keep every- one focused on and interested in the deal. The party that benefits most from keeping up deal momentum is the party that needs to get the deal done. Does the developer need money to make payroll? Does the publisher have to close the deal prior to the end of its fiscal year to get money off the books? But be careful: pushing deal momentum can result in rushing through items that should not be rushed through. You have to balance the benefits of keeping the ball rolling against the risk of a drafting or tactical mistake.
Both deal fatigue and deal momentum are real and substantial factors in a negotiation. They are difficult to control, but the first step in using them to your advantage is to recognize them and recognize the effects they have on the negotiation. Know that very sophisticated negotiators manage deal momentum and deal fatigue to increase leverage and generate other advantages for their side.
Preparing for a meeting or call
When do you have a call or an in-person meeting?
One common business development failing is to ask for a call too early, on the theory that going straight to a phone call (or an in-person meeting) will avoid some negotiating hurdles. Asking for a call or meeting too early is done in the name of keeping up deal momentum, but in practice it can slow things down substantially.
Remember: you have to dance the dance. There are psychological and actual structural/process-oriented reasons for doing the first couple of rounds on paper. Many of the common issues presented in a first draft of a document are not actual misunderstandings, they are just drafting issues that are easily solved by exchanging a draft or two. Simple items like honing representations and warranties or setting up invoicing terms do not require a meeting of any type. Those items are best sorted out by exchanging a draft or two.
While this takes time and is frustrating to people that do not understand the optimal process, doing a couple of initial rounds on paper usually ends up being the fastest way. When people see a mark-up and have a chance to think about something, they do not have to take an immediate position or dig into any particular view. If people start round one in person or on the phone, then they become wedded to ideas that do not deserve that kind of attention, and that removes the attention from larger issues.
After a few drafts are exchanged, the real issues will surface. These are items that need to be discussed, explained, and negotiated. If a call or meeting is called too early, then people spend hours talking about less important things like “What kind of invoicing software do you use, and where is your corporate form registered?” It is a tremendous waste of time and always points toward incompetent business development and process management.
If people really want to hurry, they exchange two drafts over two to three days and then have a focused meeting on the last remaining items.
When to have a call and when not to have a call
The perfect time to have a call is right after the basics have been sorted out in initial drafts. Ninety-five percent of deals for day-to-day operational items are closed without ever having to talk to the other side. Calls or meetings are important when there are larger, more difficult issues that need sorting out. Those issues require the higher bandwidth communication that a meeting provides.
In some cases, you may choose not to have a meeting or a call. This usually arises after drafts have been exchanged and there have been one or more meetings/calls. Then, there are usually just one or two issues left. In some cases, those issues are so black and white that there is no reason to discuss them. Consider the negotiating power of telling the other side that you do not want to have a call on a particular issue. If done deliberately, it conveys a seriousness about the issue that no other technique provides.
Wes Craven's Scream (1996) captures the feeling of being on a stressful, unnecessary phone call
The language below is a firm but polite way of using the “no call” strategy.
I do not want to waste your time and I do not want to give you the wrong impression that there is any daylight on this issue. We are not negotiating this point, we are expressing a requirement for the transaction. [Alternatively: We are not negotiating this point, we are explaining it.]
If used properly and carefully, this technique is a powerful way of getting your final negotiation points quickly and in a form that you want them (often without changes). Of course, beware of over-using the “no call” strategy or using it too soon. Do not violate the basic rule—you have to dance the dance. You may think that using the “no call” strategy can work to get all of your points right at the beginning or you use it as a Hail Mary when you are experiencing deal fatigue. This tactic can really only be used at the very end on one or two final points and only when you absolutely need them to be a certain way.
Also, it works best when the point is simple. If you completely need to have X dollars to move forward or need the royalty rate to be set at Y percent, or you refuse to have a “catch-all” term in the net revenue deduction—those are places this tactic works best.
Nothing is less productive in a negotiation than dishonesty—which can often take the form of bluffing or outright lying. You will eventually get caught, and the consequences will be high. You are building credibility over the course of a negotiation, and over the course of your career. And it’s very difficult to recover lost credibility.
The only forgivable way to substantially change course or alter your negotiating position occurs when your superiors give you certain marching orders to start with (“do not accept less than 20 million”) but then change their minds. But in any situation other than that, you should definitely never lie and never be seen to “bluff” or substantially change your position.
After doing a mark-up of a draft, and prior to a meeting, one side may say to the other, “There are a lot of comments in this document, can you send us a list of your major issues?” Sometimes this is framed as “to narrow the issues for a call” or because the other party is “so busy and has never seen a mark-up this heavy on their document.” This is a basic trap that you can use to your advantage on an unknowing counter-party. But you should not fall for it.
First, notice that if you force the other side to do at least one return draft and dance the dance, you cannot fall into this trap. This request shows that the requesting party is either (a) lazy and does not want to adequately review the document or (b) sophisticated and trying to see if you will fall for their ploy. The problem, of course, is that the party that provides a list of their “major issues” essentially concedes all of the other points in the document. They are saying that A–G are important to us and H–Z are less important. So, not only has the party providing the list revealed their priorities, they have also discarded items that they may have traded on, and the other side will not take any of those other points seriously. So, beware of this common trap.
Negotiating against yourself
Providing an issues list is a way of negotiating against yourself. The other side has not offered anything. And yet, here you are—giving things away. Beware of other types of negotiating against yourself. Another common tactic in this area occurs when your opponent says, “you are going to have to do better than that.” By saying that, they are offering no counter-proposal; they are just baldly requesting that you improve your position in their favor. Always force a counter-proposal whenever you can.
During a call or meeting
During a call or meeting, consider the following tactics to get ahead, and be prepared if anyone tries to use them on you:
Appeal to a higher authority or white knight
In some cases, you may want to table an idea or not make a decision on a certain point. Perhaps you do not have the authority to concede or approve a certain point. In those situations, you might say, “I will need to take that back to my team,” or “I need to check with [Insert senior colleague] on that.”
That is commonly said in negotiations and people may not think anything when they hear it, but they should. It is an appeal to a higher authority. It is a temporizing measure that allows you to pause discussions on an issue. It is also a hint that a certain issue may be sensitive. It is a layered authority approach, allowing the first negotiators to take a hard line on a certain point and then back away from that line toward the end of the negotiation when the “higher authority” or “white knight” comes in to break the impasse.
Be careful to not use this maneuver too often. If you always have to check with someone else, then the other side may get the impression that you are not empowered to negotiate the deal. The layered authority maneuver also provides a second bite at the apple.
If you want to reopen an issue, you can say that the deal cannot be finalized “until the (CFO/CEO) signs off on it.” People may use that as a way to go through the agreement, build goodwill and come back at the end for a final push on a few issues. They will come back and say, “I’m sorry but the (CFO/CEO) will not sign off on this unless we (get the payment terms down/change the price/improve the indemnity)” etc.
People have an intense desire to fill silences. There are two main uses for silence. The first is more information. On the phone or in person in a meeting, you can often get people to give you more information by just not saying anything. It sets up an interesting power dynamic where they feel they have to fill the space.
The second use of silence is in closing a point when you have explained your position and it appears that talking more would only hurt your side. There is a great scene in the 1984 classic Pulitzer Prize-winning play Glengarry Glen Ross, by David Mamet. In that scene, one of the salesmen describes selling some land to a couple at their home. He sits at the kitchen table and has them prepared to sign. He holds the pen out, sitting in silence, knowing that the next one to say anything loses.
Locking in an admission
Walls are not built with single stones. In negotiations, you often have to lead someone down a path to get where you need to go. It is critical to see the path and all of the emotional, financial, and logical steps to get to the desired goal.
Consider when someone says that, if they could have more time, they could have built the game for less money. A potential employee might say they do not mind assigning all the IP to the company as long as you exclude their side project. A publisher may say they are not going to indemnify a developer because they are not providing materials. You might ask, “But if you were providing materials, you would indemnify for those, wouldn’t you?” These are valuable admissions. In those cases, where the intermediate step is necessary to get to a larger goal, I usually repeat that back to them in the meeting. I get them to say “yes” in front of other people. When necessary, I remind them of the admission. Lastly, I often include it in some way in the documentation so they cannot go back on it later.
A concept similar to locking in an admission is the behavioral advertising concept of anchoring. Anchoring is using one number at the start of the discussion with the knowledge that people are psychologically predisposed to work around that number. Biologically, we have a bizarre and powerful susceptibility to build a negotiation around the first numbers we hear. We have extensively studied that people will start a discus- sion on everything from the potential salary of a computer programmer to guessing the number of countries in the UN, based around literally random numbers they hear before the negotiation. Whenever possible, be the person that frames the negotiation with your numbers.
This is standard
Saying something is standard is an interesting negotiation technique. Very few things are standard. What you are really communicating is that you believe you know more than the person you are negotiating against and they should take your word for it. Consider how this makes the other person feel. If you have enormous leverage or an enormous experience gap over the person you are negotiating with, this may work. However, using the same line on someone more experienced than you will undermine your authority. They will know that you either (a) actually think incorrectly that this is standard or (b) tried to use a simplistic negotiation trick on them.
"Saying something is standard is an interesting negotiation technique. Very few things are standard. What you are really communicating is that you believe you know more than the person you are negotiating against and they should take your word for it."
How often does saying that something is standard or “corporate policy” actually work? It depends on how close to immovable something is, how much it is actually an industry standard, and the leverage differential between the parties. Saying that a price, net revenue definition, or an indemnity is standard is going to be very hard to sell. Saying Apple’s developer terms or Steam’s platform terms are standard is going to be easier to sell. Keep in mind that, for enough money and with enough leverage, even standard documents and clauses with industry titans can change. Do not take this as the final answer if something is important to you.
Now that we have reviewed a number of general strategies and concepts, consider how those might play out in one of the most important agreements in game development: the publisher agreement.
Key points in the publisher agreement
Price and performance
How much does it take to make the game? Pricing is usually related to a calculation of development hours plus normal additional costs. How many hours of production, art, coding, and administration are going to be required to build the game?
Plus, there are fixed costs for office space, legal, accounting, and insurance, and there are always unexpected issues to account for. Perhaps, if a developer is very good, the developer can pad the pricing with some expected profit margin prior to a royalty collection.
How do you measure success? This is difficult, but prior to launch it is even more difficult to measure quality than it is to measure it post-launch. During development prior to launch, there will be a Game Design Document (GDD), which is essentially a specification for the creation of the game. Ideally, it will contain as much detail as possible on what will be in the final game: how many levels, how many playable characters, and what those levels and characters will be able to do.
This is only the beginning, but imagine thinking about something simple like how many trees are in the game or what the concept art looks like. How do you judge that beyond a certain production quality? Even more complex, how about overall game design decisions or story decisions? These may be generally described in a GDD, but judgment on the final product is usually made by the publisher.
After the game is launched, the measurements can be more quantitative. What is the Metacritic score 30 days after launch? How many copies have been downloaded? What are the sales? How many monthly or daily active users do we have? What is the revenue for virtual property or DLC ?
Using scales for upside or downside protection
After the development budget, there is often a royalty associated with a game. How much should a person pay for a license or a game, or for anything for that matter?
That depends on what each person thinks the benefit will be. If you think a film license combined with your game will earn 2 million dollars, it may be worth 1 million to buy it. What if it only earns half a million dollars ? When two people disagree on the value of something, one way to move past that is to use a sliding compensation scale.
The issue is time and the unknowns in the future. If both people had a perfect crystal ball, they may be able to agree on a royalty rate. Using a scale, the parties essentially model the future. This accounts for different potential outcomes.
These scales normally come in two forms. First, a milestone schedule with flat dollar figures, that may read like the following table:
Sales Figures Royalty
1 million dollars $200,000
2 million dollars $400,000
3 million dollars $600,000
Second, it could be an escalating or de-escalating percentage instead, if the parties are more comfortable with that description. Note that this could still be stated as a dollar figure, if the parties prefer. Consider this example. The party receiving the royalty (perhaps a developer or a licensor) wants some downside protection. They want to make sure that even if there are low revenue figures, they still get a certain return. In the table below, at a million dollars, the payment is $200,000 at 1 million, $360,000 at 2 million, and $510,000 at 3 million.
Sales Figures Royalty (%)
1 million dollars 20
2 million dollars 18
3 million dollars 17
In other situations, the percentage could increase as revenue goes up. This might make sense in a situation where a publisher wants to be certain to recover relatively larger amounts at lower revenue numbers, but where the developer argues, if the game is a mega- hit, that it was mainly due to superior design and execution.
One common pricing problem is the difficulty agreeing on performance measures. Objective measures are more important than ever when you disagree on potential out- comes. Varying objective endpoints as shown in the tables above allow the parties to disagree on how the world may turn out, but agree on what the result should be in varying circumstances.
What do we do if the game performs worse than expected? No one likes to consider those options, but failed games are definitely more common than hit games. So, if things do not go well or a project is canceled, what are some normal consequences?
Terminating the agreement is a normal consequence of failed development. The question is what happens after termination, and what is fair? First, there are normally two types of termination. The first is termination for breach. In this case, one party is not fulfilling its duties under the agreement. Most commonly for each side, the publisher is not making payments or making the proper payments, or the developer is not delivering acceptable game builds (or live game performance).
The second termination type is for convenience. This is another way of saying that the project is canceled, but that this is not attributable to the failure of any particular party.
Termination for breach is complex because all breaches are different. Normally, the parties exchange their version of the facts via letters and work out a settlement. That could include the reversion of rights to one party and likely some type of payment. It is hard to go beyond that description because these situations are unique.
Termination for convenience is where no party is at fault. In almost every case, this comes from the publisher’s side. Publishers are often given the right in a publisher agreement to terminate if their resource allocation plans or corporate strategy change. Developers are almost never given the option to terminate an agreement for convenience.
The examples below are deliberately open-ended to raise questions about termination. The “right” answer varies based on each situation and on the leverage of the parties involved. Reading through these and making sure they are covered in any agreement (one way or the other) will save some pain during termination.
If the game has launched, there should be a wind-down period. This allows players to disengage with the game and maximizes the revenue from the title. Retail units are sold off during this period and the live game is usually run with a skeleton team. Also consider prior sold DLC and other player purchases. Giving enough notice for the wind down is necessary to avoid a regulatory action. A state attorney general or the FTC could take an interest in a game that sold virtual goods right up to the day it was turned off.
Is there a license reversion? If the game is canceled for convenience, it makes sense to pull the license back to the licensor so that they can make another game. However, if the license is terminated for developer breach, perhaps the publisher gets a second chance to make the game with another party. And what about the sequel to the game?
Perhaps the agreement is terminated in the live game phase. Perhaps there is a developer bankruptcy. In that case, consider how one might divide revenue from the sale of assets of the game. In some cases, the publisher purchases the game or purchases the developer to prevent bankruptcy, essentially assigning all rights to the publisher.
Net revenue definition
The net revenue definition is the most hotly debated term in almost any negotiation, but it does not have to be. Consider the following net revenue definition from a game development agreement:
“Net Revenue” shall mean all monies paid to and received by Publisher from the Game sold by Publisher, its subsidiaries and affiliates, less deductions for the following (to the extent applicable): (1) state, federal, and international taxes on sale, lease or license, such as sales, use, excise, value-added and other taxes, (2) costs of insur- ance, packaging, custom duties, shipping and similar charges not born by customers, including foreign exchange rates (3) all royalty and/or license fees payable to third parties, including but not limited to platform and channel operators, distributors and those third party licensors holding rights to assets embodied in the Game; (4) price protection, reasonable reserves, costs of goods sold, credits, chargebacks, credits, free goods and promotional codes and merchandise, and additional reasonable, unaffiliated third party expenses as may be specified by Publisher, all of which shall be actual and verifiable.
So, to summarize: (1) is essentially just taxes; (2) is more taxes, packaging, and currency risk; (3) is the real core of net revenue—the actual money paid out to the platforms and licensors; and (4) is a catch-all pit, especially the last element: “additional reasonable unaffiliated third party expenses as may be specified by the Publisher.”
As you can see, this is a very publisher-friendly definition. Essentially every conceivable cost is taken out of net revenue. This is an actual fully negotiated clause where the publisher had significantly more leverage than the developer. One item that is not deducted is the cost of marketing and advertising. That was a win for the developer.
However, take a look at (4). The end of that is dangerous. It was modified from its original form, which was very developer un-friendly. The last clause after the comma,“all of which shall be actual and verifiable” is the modification, which was some help for the developer. Still, if it is at all possible for the developer, the entire subsection (4) should be removed.
Traditionally, publishers (or investors) received the money first from retailers when the games had been placed on the retailer shelves. Publishers were paid out of the first dollars and then publishers liked to make as many deductions as possible to make the net revenue number as small as possible.
Any ambiguity in the net revenue definition will always harm the developer. If the publisher states that net revenue includes the deduction of “other costs” at the reasonable discretion of the publisher, be assured that they will use that.
One argument for developers is to specify that the publisher must be very experienced in the distribution of games. Of course, the publisher has to agree.
As a result, the publisher should know what types of third-party costs are involved in the distribution of games. Publishers should also have other developers that they have provided royalty reports for. Developers should consider asking publishers for a few redacted reports from other similar games. Ask for sample calculations based on these real reports and include them as exhibits to the agreement.
Hiring and new company investment
I am commonly asked about creating a “joint venture” or helping a company buy part of a project or part of another company. These are corporate transactions. They will usually be complex, with substantial legal fees and certain tax consequences.
In some cases, this may be exactly what the clients are intending, but in many cases it is not really their intention. They do not actually have to own stock in something or options in a corporate sense, they just need the effects of ownership, like control and a revenue share. In this short section, I will propose some alternatives to corporate ownership that are useful and simple. These can be used between two different companies or individuals. They are commonly used in an employment context as well as a development context.
Start with this question: Do we really need corporate ownership? Do we want this to be a stock transaction? Do we want to deal with the tax consequences of ownership? Do we want to deal with corporate formalities like forming an entity, doing accounting for it, paying yearly taxes for it? Do we want to deal with voting and annual meetings and other corporate formalities?
In the case of large companies getting together and putting millions of dollars into a project, the answers to the questions above are usually “yes.” Large corporations work well with other corporations doing actual corporate work. The associated cost and annual filings are not a large issue for a company. However, in many cases, actual corporate work is not necessary.
If all the parties want is to assign ownership, assign control, pay back an investment, or divide up revenue, a simple IP agreement is usually enough. Imagine working with a senior consultant or investing in a game studio. In that case, even if the amount of money is in the millions of dollars, an IP agreement could be all you need. In that case, the parties can assign ownership to one party or to both parties.
They can decide where and how the project will be launched, including distribution and sequel development. They can work out the investment amounts, payment schedule, recoupment, and a royalty distribution. All of that can be done in several pages over the course of a few days to weeks. It is usually less than one-third the time and cost involved in working up corporate documents.
On a related note, consider a consultant or founder who insists on “owning” part of the company. The “simple” way to achieve this is to grant that person equity or options in a corporate sense. This is what everyone thinks of first, but it may not be best for everyone. Those shares come with a tax burden. They come with ownership rights and voting in the company. They also usually do not go away. If the person leaves after working on the project for three months, they usually still own those shares.
Instead, consider simulating equity using something called synthetic equity, or less popularly, phantom equity. The idea here is to give all the upside of equity without the downside. This is a contract right that acts just like equity if there is a sale. But, there are no voting rights and no tax burden. Also, if the person leaves or is fired, you can sunset the synthetic equity over a period. If the person works four months, leaves, and then the com- pany is sold five years later, you can set it up so that you do not owe the person anything.
The point is not to take advantage of the person. The point is that synthetic equity allows the parties to create a custom solution that is fair based on the deal. It is a contract right that is not tied to how equity and options work. It is flexible and should always be consid- ered as an option for hiring new people and motivating executives.
Some final words
The second half of this chapter is devoted to re-publishing an essay originally written for the Vilnius Games Conference in 2016. Please forgive that some of the material in the essay repeats and expands on the material above. In everything from independent contractor agreements to game publisher agreements, far too much value is given to “owning the code.” Do not find yourself on the wrong side of this ubiquitous illusion.