Tag Archive for business formation

The Finer Points of Starting your Development Company [Part III]: Formation

March 31, 2008 Business Planning No comments

Before You Get Started:

Before you start sending out applications and visiting city hall, you need to determine what kind of business you want to set up. To do this, you will want to take your business plan, including your financials, to both your attorney and your accountant. You may also want to consult the helpful volunteers at SCORE and SBA, as they work with quite a few start-ups. Your attorney will want to insulate you from as much personal risk (to the extent that you are exposing your personal finances to personal risk) as possible, while your accountant will want to ensure that whatever entity you elect will get the best tax treatment possible. They may recommend that you fully incorporate (if you require investors and shareholders, and you require substantial start-up capital), or they may suggest one of the other "limited liability" entities at the beginning stages of your company. The checklist below is for the formation of an LLC. While the formation of business entities is on a whole fairly uniform, if you elect to organize as another entity you must a) first make sure that your state recognizes such entity as a valid business form, and b) comply with all local, state, and federal rules and regulations with regard to business formation. Therefore it is always helpful to have a lawyer at this stage in your business planning. Another question you want to ask yourself is where you want to register your entity—while it is typically problematic to organize your small business in a state other than your principal place of business, some states such as Delaware offer tax incentives for entities who register there. Many states do not require that the business members or board live in the state where the entity is registered. A post office box under your business’s name may be sufficient. Keep in mind that your business entity is distinct from you (depending on the entity), and your entity can legally exist in two places at once (where it is incorporated and where its principal place of business is).

LLC Checklist (note: the following applies to business entity creation in the US. Businesses that wish to operate in foreign countries should consult legal professionals in your region):

DBA (Doing Business As): Any business that uses a trade name or name that differs from the name that appears on the Articles of Organization must obtain a DBA. This is the name you want your company referred to in contracts, bank statements, and other transactions and investments. Many banks require that you provide your DBA prior to opening a business account. DBA’s have an added benefit for LLCs in that they allow game developers to use a different DBA for each game or website they create without forming an entirely new entity (there may be other reasons to organize each game in development as a separate business entity, however—this is something that will be discussed in later entries). You can have one LLC and multiple DBAs.

Obtaining your DBA varies from state to state, county to county, and country to country. If you are located in the US, you may want to the contact the office of your Secretary of State or the County Seat to determine how to obtain a DBA. If you are in another country, contact your local authorities (starting at the city level—i.e., city hall, mayor’s office– and working your way up) to determine how to obtain the proper registrations.

Articles of Organization: Your Articles of Organization have serious legal consequences, and should therefore be drafted by or with the assistance of an attorney. Similarly, you must be very careful that your Articles of Organization and your business’s Operating Agreement do not contradict one another. Your Articles of Organization may include:

a) Your business’s name and principal location,

b) The duration (or how long you expect to be in business to operate),

c) The business’s purpose,

d) The name and address of the Agent of the company (individual assigned to receive service of process and other legal documents),

e) The initial Capital invested by the company and its members,

f) Division of Ownership of the company,

g) Winding up/Termination of the Company,

h) Management of the company—i.e., who is in charge of what,

i) Indemnification clause, stating that the entity indemnifies its individual members as to all claims arising from doing business.

The requirements for the Articles of Organization may vary from state to state, country to country. It is in your best interest to consult a lawyer familiar with setting up small businesses.

Operating Agreement: Your operating agreement will set out the finer points of your company’s management, finances, organization, and ownership structure. This is an agreement between the members of the company that sets out how the company is to operate. As a result, it will vary drastically from company to company. As noted above, it is very important that your operating agreement does not contradict the Articles of Organization—a contradiction may cause your operating agreement to be voided unless the particular contradiction is severable from the rest of the agreement. Once again, a lawyer is very valuable at this stage.

Federal Registration: As a business with salaried employees, you will need to obtain Federal Tax ID number and an EIN (Employer Identification Number). You can obtain the forms for these ID numbers at the IRS business portal.

State Registration: You will also need to register with the state where you plan on organizing. Note: This can get tricky if you are registering in a state other than your principal place of business. Before making that decision, consult an attorney and make sure it is in the best interest of your company. Also, read the "miscellaneous issues" section of this IGDA article. To register with a state, you typically need to provide a registration form, a registration fee, and a copy of your Articles of Organization.

County Registration: In many states, you may be required to register your business in the county where you plan on operating. To do this, you need to visit your county seat/satellite office or go online to fill out the registration form. As this may also be the place where you register for your DBA, you may be able to accomplish these tasks at the same time. Different counties have different rules—some may require your Articles of Organization while others do not.

Municipal Registration: You must register as a business within the city where you plan on doing business. This usually means a trip to city hall/town hall or your local court house to fill out the requisite application forms.

Keep in mind that you are accountable for Federal, State, County, and local/city taxes. All of these registrations are almost entirely for that purpose only. However, some locations have specific regulations. Most of the offices where you register will provide you documentation of those specific rules and regulations. If they do not, it is your responsibility to educate yourself about the rules and regulations that apply to your business. As an LLC, you can elect how you want to be taxed– whether as a sole proprietorship/partnership, a C Corp, or an S Corp. How you want to be taxed depends entirely on your business’s needs, and you should always consult an accountant when making this determination.

 

 

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

March 29, 2008 Business Planning No comments

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.

The Finer Points of starting your Development Company [Part I]

March 28, 2008 Business Planning No comments

I previously went over some of the general characteristics, advantages, and disadvantages of small business types. I’d like to discuss one more small business type before discussing entity formation.

S-Corporation

For tax purposes, an S-Corporation is a federal tax classification that permits the entity to not be subject to an income tax (similar to a LLC). Instead, all profits and losses pass through to the shareholders and are taxed on their personal tax returns. The election to be treated as an S-Corp is based almost entirely on tax treatment. The fees associated with being treated as an LLC in some states (such as CA) may turn out as greater than they would be if you elected S-Corp treatment. 

In an S-Corp, instead of members (as you’d have in an LLC), you have shareholders. Those shareholders are subject to a pro rata tax, to be claimed on their personal tax statements, based on profits earned by the business. This means that shareholders are taxed based on the number of shares they own in the business. A majority shareholder will be responsible for a greater proportion of the taxes on the earned profits. This also means that shareholders who are employees will pay FICA taxes on their salaries as well as income taxes on their portion of the company’s profits. This isn’t necessarily a double tax—the salary is subtracted from the profits prior to application of the federal income tax. Non-employees are only required to pay the income tax commensurate with their ownership in the company.

Because shareholders are taxed whether or not there is a cash disbursement of profits, it is advisable for S-Corps to provide cash disbursements of profits to shareholders that are at a minimum enough to cover the taxes themselves. This is usually set out in the shareholder agreements.

The decision to be treated as an S-Corp. should be between you and your accountant. You get the same legal treatment as other limited liability entities, such as LLCs, LLPs, and C-Corps. Deciding to elect S-Corp status is usually something you can determine when you are filling out your annual or quarterly tax information.

Forming a Business Team

Developers take great care in deciding who will code, design, and manage projects. At least equal care should be taken when deciding who you want to help you run the business portion of your business.

Your Lawyer: Developers want entertainment attorneys. Why, you ask? It is much harder to break attorneys in non-entertainment industries out of the habit of negotiating unfair clauses. Entertainment lawyers are experienced in working within the confines of a bad deal, because they understand how leverage has worked to manipulate every facet of the entertainment industry. Publisher/developer deals are inherently unfair, and the people who understand this best are those who have also worked with record deals and studio deals. Good entertainment attorneys will be able to squeeze the best deal possible for a client out of what will ALWAYS be a bad deal. Entertainment attorneys also work with many of the contracts and issues we’ve discussed previously, including intellectual property licenses, work for hire licenses, and NDA’s. This doesn’t mean that you have to hire an entertainment attorney—especially considering the number of sleazy entertainment attorneys out there.

A bad attorney is worse than no attorney at all, so the practice area is less important than your lawyer’s commitment, ethics, and willingness to learn. What do you need a lawyer? You need someone with a very strong understanding of all of the Intellectual Property issues that arise in gaming. You want an attorney with transactional experience, one who can take apart a contract and explain it in plain English. You also want an attorney who can write the kind of contract that specifically applies to your transaction. It should be noted that law schools don’t spend a lot of time teaching students how to deal with contracts. Law students are practically force fed litigation in most ABA accredited schools, and they only learn about contracts when they get into practice.

Most importantly, you want an attorney who cares about what they are doing. A good attorney will always take the time to find the best answer if she does not know it off hand. Similarly, a good attorney will learn about the industry her clients specialize in by taking the time to read about the industry, the issues, and the kinds of transactions involved. Good attorneys don’t rely on their gut, and they don’t give simple one word answers. It is not the attorney’s job to make decisions for you. Instead, it is the attorney’s job to lay out the array of possibilities ranging from worst case scenario to best, and provide counsel on what actions will lead to the best case scenario. A good attorney leaves the final determination to the client and consults the client when doing anything on behalf of a client.

Look for someone who cares about your work as much as you do and someone who returns your phone calls. Any time you’re deciding on an attorney, make sure you get references. Ask for a list of their past clients, if available. If not, as for the names of other attorneys who are able to vouch for the one you are interested in hiring.

Be careful about hiring your friends. Get everything in writing and make sure you get a copy of the fee arrangement, regardless of how well you know the person. It is also important to make absolutely sure that your attorney has a reputation for discretion and confidentiality, ESPECIALLY if you are hiring an entertainment attorney. A lot of very prominent and successful entertainment attorneys have a very bad habit of disclosing proprietary and/or confidential information about cases and transactions they are working on to increase their own personal leverage and clout. It’s important that developers in particular stay away from this kind of lawyer. Also, check out a recent article by Tom B. for how to train your attorney– this should be required reading once you’ve found an attorney you want to work with.   

Your Accountant: The responsibilities of your accountant are no less rigorous than the responsibilities of your lawyer. Your accountant is your financial guru and unless you have a background in accounting yourself, someone you must trust implicitly. As with your lawyer, your accountant should have a good grasp of your industry and the kinds of transactions you will be engaging in. Your accountant should also be aware of some of the tax issues that may come up for digital distributions and brick and mortar distributions (sales tax, VAT tax, etc.). As with a good lawyer, it’s important that your accountant cares about your business and has a reputation for honest business practices. Once again, you will probably want to get references.

Your Business Manager: For many small developers, the business manager is also the lead developer or the project manager or the CEO of the company. That being said, your business manager is responsible for the day to day business of your company. This includes payroll, hiring and firing, enforcing business practices that protect proprietary information and trade secrets, managing documentation and data, marketing and advertising for your company, and negotiating deals with third parties for SDKs, manufacturing and distribution, game engine licensing, and licensing your own products to others. If your development team is the pumping heart of your organization, your business manager is the brain that keeps the rest of the body of your business moving. Ideally the business manager is the person most invested in the success of your business, as she is the person most responsible for the business’s success or failure.

Your business manager should be a voracious reader. She should read all of the primary trades both online and off (PC Games, Game Developer, GDNet, IGDA white papers and articles, the Byron Report, news sites and blogs). She should also read books about business management. Because she’s the business manager of a development company, she should read books and articles specifically designed for the governance of those kinds of companies. She should understand the development process. She MUST be able to make tough decisions, such as firing or disciplining individuals for bad conduct. In short, your business manager should be an intelligent hard ass who lives and breathes your company’s business. She can be less of an obsessive hard ass if your company is in a position to delegate some of her duties to others, but typically it’s good to have someone who is just that committed.