Publisher Developer Deals and the Buyout Provision

 Tom Buscaglia's recent article on Gamasutra discussed some very important points that game developers should take to the table when negotiating a deal. He also pointed out a new contract model that caught my interest.

    "I recently ran into a really clever ploy by publishers. In order to overcome the objection to IP assignment for original IP games, instead of demanding the IP ownership in the deal, publishers are     now allowing the developers to retain IP ownership until after the game is released. However, the publisher retains an option to buy out the IP (and in the process the developer's rights to a back-    end royalty in the process) if the game performs above a certain level. What level, you ask? Well, it is inevitably some time before the advance recoup point when back-end royalties would normally     kick in if the game is a hit! You really have to admire their guile. If the game sucks, the developer can keep the IP. But if the game is a hit, the publisher owns it and the developer gets screwed out     of any back-end royalties in the process!"

     Tom pointed this out as an example of the ways in which publishers attempt to exploit game developers, and there is no question that this particular model can be seriously abused by publishers. However, Tom's primary point was the developer's need to carefully negotiate and think through the process of deal making. With that being said, this raises the question of whether, by way of negotiation and valuation, the buyout model could ever potentially benefit the game developer.

    The Potential Benefits of a Buyout Provision

    Obviously, there are times when a buyout provision is a very bad idea. If a developer agrees to a $1,000,000 buyout once the game reaches a sales threshold that indicates a blockbuster, the deal isn't benefiting the developer at all. However, if the buyout provision takes into consideration the actual and future value of the product if that product reaches a certain sales milestone, the deal could be a very good one for the developer if the developer otherwise wouldn't see a royalty off of Net revenue (which is very often the case). It is possible for the game to be successful while the developer only barely breaks even. With ever escalating development costs and the tricky structure of Net revenue, not to mention a short publishing cycle (in most cases only 3 years), it's rare for developers to ever see anything after the advance.

    I covered royalties previously, so by now it should be clear that royalties aren't ever a guarantee. If a game costs $10,000,000 to make, the game is selling for $40, and the developer is taking 15% of Net after recoupment (which discounts cost of production, third party distributions, reserves, etc.), the game will have to sell almost two million copies before the developer would see a dime ($40 * 2,000,000 = $80,000,000 * .10 [approximate and probably highly underestimated deductions from gross] = $8,000,000. $80,000,000 – $8,000,000 = $72,000,000 * .15 = $10,800,000). Two million copies is a very respectable number as far as games sales, and most games never do that well. If you get a buyout provision that is triggered at 1 million sales, and the game never sells more than 1.5 million, under the above formula a buyout provision for $10,000,000 to the game developer would be a substantial windfall.

    These are hypothetical numbers, but it demonstrates the point—it isn't necessarily the deal model that is bad, but (as Tom pointed out) how the deal is negotiated that determines the deal's worth. The difference between a royalty rate and a buyout provision is the difference between purchasing shares in a mutual fund and betting at the race track. With a royalty rate, there's a fixed rate of return for as long as the game is published that is based on the game's success in the market. With a buyout provision, you are playing the odds and betting that your game will be a winner. Investing in a mutual fund is responsible, but it doesn't always guarantee a return (look at the current market). A buyout provision doesn't guarantee a return either, unless your game is a success—however, if the game's a success yo may stand to earn substantially more than you would earn under a traditional net royalty formula if your valuation is higher than actual sales. You are betting on those odds, you want to bet high, and you want to negotiate the highest number you can get.

    Valuation under the Buyout Clause

    The key to a fair buyout provision comes down to valuation. It also comes down to the questions you need to ask yourself when contemplating a deal:

  • How do you determine the game's value once it's achieved a certain level of success? How high can you push past the sales milestone to determine the game's worth?
  • What is being sold?
  • How do you come up with a number?
  • Should you rely on the amount the developer would have earned by the end of the publishing cycle?
  • Should you rely on the game's net worth to the publisher?
Ideally you want to anticipate the best possible outcome—so your projections should include all sales on any current and future consoles, any possible derivative uses that could lead to future income for the IP owner (i.e., film rights), and the inevitable likelihood of sequels. Other things to keep in mind as the developer are ancillary rights (merchandising), right of first refusal for sequels, OEM and bundling rights, and buy back provisions should the publisher choose to not exploit the work.

Any deal can hurt the developer if the developer devalues their own
work. The key is having faith in what you create and allowing that
confidence, good sense, and perseverance (as well as a good lawyer)
guide you through the negotiation process.

 

Once again, thanks to Patrick Sweeney for his valuable input.    

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