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?

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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Good law professors* will tell their students that when looking at any agreement, your first job is to examine the position of the parties. Any good lawyer who works with contracts and every developer who signs an agreement must go through this analysis as well. You first determine what the parties’ roles are, and why each party wants to get into this relationship. You then look at the leverage between the parties. When we talk about leverage, we’re talking about the bargaining power of each party compared to the other party. The L word is all important in contracts. In the case of new or independent developers, it will typically dictate how negotiations go and what that developer can expect to get out of a deal.

It is also why dealing with a company or individual with substantially more bargaining power can be highly problematic. There may come a point where the party you are dealing with will have the ability to say "take it or leave it," which is typically never good for the developer, especially if nothing has actually been negotiated yet. This is often something seen frequently in the music industry—artists get so excited about the idea of being signed to a major label that the label may be able to unilaterally dictate the terms of the agreement. While I would like to believe that developers are a bit more sophisticated, there is still a giddy-component that should be quelled prior to committing to any agreement. One way to quell this is to look at the statistical success of entertainment products. Most fail. There is a good chance that yours will too. The best way to ensure that your game product won’t fail is to work with other people who believe in your product. Regardless of what publishers or other companies may whisper in your ear to get you into bed with them, if they aren’t willing to negotiate in writing then you can be sure that your product will not get the kind of attention, care, and protection it needs to be a success.

So first some rules of thumb:

1) ALWAYS have your own attorney who you trust, who knows what you want, and who is familiar with game industry contracts redline any agreement put in front of you;

2) NEVER trust that when someone says, "it doesn’t matter if the contract says X, we promise we’ll do Y instead," that will actually be the case. One, oral agreements are rarely enforceable when a written one says something to the contrary. Two, if the other party legitimately plans on following through with Y promise, there’s no reason whatsoever to keep X in the agreement;

3) Be very careful when someone says "this is standard industry practice." Make sure that is actually the case. More to the point, if it is something you don’t feel entirely comfortable with (such as a unilateral NDA during contract negotiations), you shouldn’t agree to it unless the other party can give you a valid reason for its existence beyond the generic "standard industry practice" argument.

The typical situation where leverage is an issue for developers is with publisher deals. First, it’s important to educate yourself about the typical issues that come up in game publishing contracts. It’s also important to figure out what your needs are as a game developer. Will you need large milestone payments to cover development costs, or is your product already in the can? Will you have any other income from other projects to cover payroll and overhead in the event of a late milestone payment? What SDKs do you need, and would it be cheaper for you or your publisher to get them? What systems will you port your game to, and what localizations will be required? What do you need to keep your lights on in the event that the publisher pulls the plug on the project? Is there any technology or software that you want to retain the rights to that are distinguishable from the game product itself (i.e., an engine you can relicense to another developer or publisher)?

You need to have a clear view of what you want. You also need to inform your lawyer of your needs so she knows how best to protect your interests. You also want to ensure that your lawyer’s ego doesn’t get in the way of a perfectly healthy business relationship—there are many horror stories where perfectly good deals were ruined when the hubris of lawyers taking precedent over the needs of the clients. If you know your lawyer well enough and your lawyer is familiar enough with your business this shouldn’t be an issue. However, it is something to pay attention to if you’re hiring a new attorney to work on a deal.

Milestones

Milestones should always be negotiable and determined primarily by the developer. You should be able to set the pace and income required for the development of your game. Milestone schedules will vary based on the complexity of the project, and the milestone payments should be sufficient to cover costs until the next milestone payment. This is one area where ideally a publisher and developer will work together to come up with the best schedule for the game. It is also where the developer should be extremely assertive and cautious. As there very little I can say that hasn’t already been stated far more comprehensively here, I just have one more thing to add: publishers may demand a cure period for delayed payments—make sure that this cure period is at a bare minimum and at least ask that it be removed. It certainly shouldn’t be the same as the cure period for a delayed milestone submission for approval. You should also ask your lawyer to make sure that delayed payment is a material breach. It takes very little effort to cut a check. Don’t give them permission to slack.

Rights Ownership

Typically, a publisher picks up a developer to develop a game. In those cases, the publisher will want the game to be a work-made-for-hire. This means that the Publisher owns the IP to the game. As a developer, you want to limit that as much as possible. This is especially true if you a) brought a mostly finished or finished product to the developer, b) came up with the storyline and design of your game, and/or c) are using your own engines or other technology in the game that can be used and licensed for other games. The most common method to protect those interests is to specifically exclude them. In the rights ownership clause of a publisher deal, it will spell all of the rights the publisher owns in and to the game. If you want to protect your interests in the characters and story, you may want to try reserving rights to create derivative works and ancillary products based on the underlying story/characters. If you want to protect your interests in pre-existing tools and technology, your contract should contain an appendix or schedule spelling out the specific technology you want excluded in the work-for-hire and assignment clause. If you are giving the publisher a finished product then the agreement will be very different—there are no development costs, and therefore no milestones. The agreed upon price is therefore the value of the intellectual property, or the percentage of the intellectual property you are selling to the publisher. So rights ownership, like milestones, varies depending on the deal. You and your lawyer should therefore be able to negotiate based on what you’re actually bringing to the table.

Contingent Compensation

Your royalty is based on "Net Receipts". What are Net receipts? This is actually a fairly complicated question that can be reduced down to simply "what the Publisher thinks it means." It may be spelled out in the agreement as "all monies received by publisher and its affiliates, subsidiaries, assigns and licensees less customary reserves, cost of goods sold, returns, lost and damaged goods, promotional units, rebates, trade/marketing discounts, allowances and credits in connection with the game," or something similar, but if you take a close look those terms are fairly vague. "Customary reserves" customarily means a percentage of revenue held by the Publisher to cover the cost of returns, so when you see "customary reserves" as well as "returns", this is redundant and may be a way to double dip. "Cost of goods sold" could include not only the manufacturing costs, packaging expenses, and third party license fees, but may also include third party claims to royalties that supersede your own.

Most importantly, your advance (i.e., your milestone payments) is recouped from your royalties. This means that the publisher first pays itself, at your royalty rate, until your advanced is paid in full. This means that if you have a 30% royalty rate and a $6,000,000,000 advance, your game will have to make $20,000,000 in net receipts before you are entitled to a royalty. As we’ve already determined that net receipts in and of themselves are pretty tricky, the amount the game needs to make at gross may exceed $20,000,0000 by a substantial margin. Game developers typically don’t expect to see royalties, but in the event that your game is a huge success, you definitely want to make sure you know when you’re entitled to income. To that end, you want to make the language concerning Net Receipts as clear as possible. You also want to try to classify money in the pipeline (that is, money earned from sales but not yet received by retailers/distributors) as monies actually received (distributors and retailers are affiliates and licensees, but it’s still important that this is spelled out for accounting purposes).

When you are entitled to contingent compensation, you should also make sure that you are entitled to proper accounting and the right to review books. For more on this, read this article.

Representations and Warranties

Typically Publishers won’t promise much in the way of representations and warranties. However, you as the developer are expected to promise quite a bit. While it’s important to limit your own risks, you also may also want the publisher to assume the risks for its contribution for the game product. For instance, if the publisher provides licenses for engines or other middleware, you want the publisher to warrant that the publisher has acquired all of the necessary rights and licenses for the content it contributes. You also want indemnification for any claims arising from that content.

The sampling above is just a taste of the major negotiable issues in a publisher/development deal. The key here is always the same—leverage and position of the parties. Your ability to negotiate depends on your ability to leverage your product against what the publisher is offering you. While your negotiating power with EA may be non-existent, independent game publishers like Gamecock take their developers seriously and work hard to do what’s best for the game. If your publisher isn’t willing to negotiate and expects you to take the deal as is, there’s a very good chance that this is not the publisher for you. There will almost always be unfair clauses in these kinds of deals. That’s the industry standard within the entertainment industry as a whole. The people with the money set the industry standards, and they are not often developer or artist friendly. The object of the game is to get the best deal out of what is an inherently bad deal and increase your ability to bargain as you bolster your reputation and increase the value of your product.

*  Special thanks to professors Patrick Sweeney, Robert Lind, Michael Epstein, and andre pond cummings.