The Finer Points of Starting Your Development Company [Part II]: Financing

Financing is very important for serious independent developers. Game development is considered a high risk venture by most lenders. Therefore obtaining financing for your project can be difficult. However, that does not necessarily mean that financing will be impossible. Depending on your credit situation, your business planning, and your ability to sell your product to investors you may be able to secure an amount sufficient to make the game you want to make. 

The Game Financing Toolkit:

Your Business Plan: Your business plan is the design document of your business—it describes your company, the product or service you are providing, the costs of providing that product, the marketplace for your product, your advertising and marketing campaign, the funding required to ensure adequate capitalization, your location, your competitors, biographical information about the controlling members, and your financial data. A more comprehensive outline can be found here. Your business plan is what you use to sell your game and your company to investors. Therefore your business plan should be professional and realistic without underselling the value of your product. You are trying to convince people that your product is a good investment. Therefore your business plan should demonstrate your ability to plan for a variety of contingencies (worst and best case scenarios) and insure solvency in both. You may also consider providing a DVD that offers a visual representation of the quality of product you want to produce.

Your Financial Data: This is technically part of your business plan. However, a good set of financial data is necessary to determine how much you are asking for to guarantee ideal capitalization without having to make burdensome loan payments. It also gives your investors a month-by-month analysis of your profitability. Your financial data should be both month to month and quarterly, preferably in excel spreadsheet format. It should document your profits and your losses. It should record all anticipated variable and static expenses associated with your product (a variable expense is the one off license fee of a SDK. A static expense is your recurring office rent). Most importantly, it should set out your break-even point—that is, the point in time when your net profit (less royalty payments/taxes/etc.) from product sales matches the investments made by you and your investors—that is, the point where you become profitable. If you are unsure how to manage all of this information, you should definitely consult an accountant. If you can’t afford an accountant, you may also want to consider visiting SCORE, an organization of retired business professionals who give new business guidance. Actually, I recommend that you visit or contact SCORE whether you have an accountant or not—the experience and advice the volunteers can provide is an invaluable resource. Those individuals may also be able to connect you with other business people and potential investors who can provide guidance for your business.

Your Business Card: Your business card should be stapled or paper-clipped to your business plan, and should provide all of your relevant contact information. Your business card should include the name of your company, your name, your business mailing address, your business phone, your cell phone, your e-mail, and your website information. You want to avoid overly extravagant or bright business cards—they typically come off as unprofessional, especially when you’re dealing with representatives of financial institutions.

Potential Investors:

Yourself: Depending on the costs associated with your game project, you could fund the start up costs independently. If you are smart with your finances and have a personal savings plan in place, this is  the only sure way to avoid financial liability to others. This is the best option if your start up costs are small. If you are developing with others, small contributions from every participant can often be enough to get the game off the ground, and agreements can be put in writing to provide for pro rata disbursements of profits once the game sees sales. If you aren’t in a position to fund the development entirely on your own, you may consider some of the alternatives.

Friends and Family: A lot of people feel awkward about asking friends and family for money. If you are uncomfortable with the thought of engaging in business transactions with your friends and family, or if you feel it will put a strain on your personal relationships, I wouldn’t recommend it. However, if you are professional and you execute private loan agreements that give your friends a family a better benefit than they would get for a CD or other traditional investment, this could be advantageous for everyone involved. A practical note: unless you can capitalize to ensure immediate monthly repayments on your loans, you may want to consider deferring repayment until your anticipated break-even point. Otherwise, include loan repayments as part of your static expenses. I say this in the friends and family portion because the investments made by friends and family may come as a loan as opposed to an interest or the purchase of shares in your company.

Angel Investors: Angel investors are individuals who invest their own money in small business ventures. They do not belong to any venture capital firm or financial institution, and they typically invest to see a higher return than they would get through traditional investments. Sometimes they invest just because they like the idea of a product, or because they want to encourage a particular industry or business practice. In other words, the motivations of Angels are as different as the individuals themselves. Finding Angel Investors can be difficult—they typically do not publicize, and they usually rely on their own networks to determine what businesses they want to fund. A useful guide to locating Angel Investors can be found here.

Venture Capital Firms:  When particular investments (such as the success of a prospective game) are too risky for traditional financial institutions, venture capital firms tend to pick up the slack. Venture capitalists purchase shares of high risk, high return companies and projects that are typically new to the market place. Venture capital firms also typically provide business and marketing advice. However, venture capital firms usually only work with large sums—typically upward of a $1,000,000 (sometimes more). As a result, it will take you longer to reach your break-even point. This is something you want to keep in mind, especially if the venture capital firm isn’t your only investment source. A list of venture capital firms can be found here.

Small Business Loans: Very few banks currently offer loans for start-ups. Most banks require a minimum of 6 months to 2 years in business before you can even be considered for a small business loan. Many banks require collateral in the form of your software, hardware, and development tools (i.e., computers, servers, etc.). The primary guarantor must have a credit score of at least 640 to even be considered for a small business loan—this isn’t unreasonable, and most investors will check the guarantor’s credit report prior to investing. However, banks tend to have more rigid rules about this sort of thing than other lending institutions. A higher credit score (close to or above 800) can significantly decrease your interest rates. However, it should be noted that many institutions will only lend you up to your current credit line without collateral. Therefore, if you have a credit card with a $1000 limit, you may only be able to get a loan amount for that much unless you having collateral backing the loan. For more information on obtaining a small business loan, contact your regional SBA office.

Publishers: In the game industry, the primary financiers of games are publishers. However, as a full blown discussion on pitching your game to a publisher and the agreement that will follow is better suited for another entry, we’ll keep this entry limited to purely independent ventures. In the interim, you absolutely must read Tom Sloper’s article about selling your game.

Insuring your Product:

Many lenders will require that you seek some kind of insurance coverage for your product. Because games are huge productions and because there is always a potential for infringement claims, investors want to make sure that your company won’t go broke if one or two people try to say that you ripped off their idea or used their trademark or likeness in a game.

The insurance providers who provide E&O insurance are obviously taking a big risk. As a result, E&O insurance typically has a higher premium than other insurance types.  This is something you want to take into consideration when you are getting capital. Ideally, you want to have "library" E&O Insurance, which provides general coverage for all of the games that you own the rights to, and you also want E&O coverage for each individual game that covers the time period between pre-production to three years after release. In fact, publishers typically require their game developers to obtain E&O Insurance for each game title, between $1,000,000 and #3,000,000 in coverage on a per claim/per occurrence basis.

To get E&O Insurance, you need to perform clearance on your game. This means dissecting your game scene by scene, line by line, and pointing out any possible IP infringement, defamation, invasion of privacy, or other claims that could potentially be raised as a result of the content of your game. ***Note: The likelihood of the claim’s success DOES NOT MATTER. Because simply defending a claim can present a huge risk to your finances, even a totally meritless potential claim can be harmful*** It also means resolving every potential claim immediately—for instance, getting permission to use any names or likenesses that are in the game and that are not purely coincidental, getting licenses for any underlying code, engines, or SDKs, getting permission or licenses to use any trademarks that you’ve included in the game or associated with your product, and in all other ways reducing your exposure in every way possible. You should definitely get a lawyer or other experienced professional to handle game clearance. Understand this—insurance companies will NOT insure you if you do not take the steps to minimize your exposure in every way you can. As I said before, E&O insurers are taking a risk when they insure game and film products because of the ease with which someone can claim infringement. Failing to get insurance can seriously damage your ability to get funding, so it’s something you should take very seriously.

For more information on getting E&O coverage, check here.

Up next: The Formation checklist for getting your business licenses/tax ID numbers.