Introduction: A Game of Risk
There is nothing simple about starting your own company. There are major risks and potential financial burdens that you will step into if you decide to set out on your own. Being your own boss takes discipline, financial responsibility, and serious determination. However, it is also potentially rewarding and, in some instances, even lucrative.
The games industry is a high risk and high stakes business. Setting out on your own in a risky industry obviously requires careful thought and a realistic assessment of your goals and needs. You should first ask yourself whether you are financially, emotionally, and personally able to handle of consequences of lean and difficult times ahead. There are several business planning books on the market that start with checklists that provide a quick and dirty risk assessment. However, how much of a risk it is to you depends primarily on your own experiences, abilities, and resources.
This article is not meant to convince you to set out on your own. Quite the contrary, it will probably scare many people away. The rewards may be slow to come, if they come at all. Some of the resources provided below can be helpful to those who pursue game development as a hobby and would like to sell their product. The bulk of the information is dedicated to providing information to those who are seriously pursuing the independent production and release of their games.
This article is the modification and adaptation of several blog articles written over the course of a month. I'd like to thank the folks at GameDev.Net for giving me the opportunity to share this with you.
Part II: The Logistics
Once the building blocks are in place to create a foundation for your business, you should start focusing on the details. The most common clich?s are sometimes the truest--in this case, you need to spend money to make money. Where do companies get start-up capital? How do we deal with those preliminary expenses like purchasing equipment and paying our attorneys? Obtaining financing is a goal and a means to an end. There are steps you need to take to obtain financing--namely the creation of your business plan, putting together your projected financials, and locating investors. Once you find investors that are willing to take the plunge with you, you can register your business with the state.
Financing your Company
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.
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 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 have collateral backing the loan. For more information on obtaining a small business loan, contact your regional SBA office.
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 article, we'll keep this description 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 Error & Omissions (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.
The Finer Points -- A To Do List
Once you've determined the whys and wherefores of how to finance your business, you need to actually create the entity. Every distinct entity has particular requirements for tax and regulation purposes. It's necessary to comply with those requirements to ensure proper tax treatment and, in the case of corporations and LLCs, to maintain limited liability.
Before You Get Started
One burden you want to avoid is doing this more than once. Therefore it is important to take the necessary steps to do it properly the first time. That means getting all of your ducks in row as far as figuring out your entity, financing, and business team before you start filing your paperwork with the government. 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 an 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. 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:
- Your business's name and principal location,
- The duration (or how long you expect to be in business to operate),
- The business's purpose,
- The name and address of the Agent of the company (individual assigned to receive service of process and other legal documents),
- The initial Capital invested by the company and its members,
- Division of Ownership of the company,
- Winding up/Termination of the Company,
- Management of the company--i.e., who is in charge of what,
- Indemnification clause, stating that the entity indemnifies its individual members as to all claims arising from doing business.
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.
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.
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.
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.
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.
Keep in mind that this is only the beginning. Once you deal with these details, you actually have to work. The good news is that if you take care of your business the right way the first time, you won't have to go through the process again. However, you should never just hand over the business details to your business team and treat them as out of sight, out of mind. If you are in charge of your own business, you can't simply focus on the fun parts and ignore the rest. You have to wear more than one hat, and you have to walk the tight-rope between both sides of the game development business- the business side and the development side. Becoming too complacent with the business aspect of your business will burn you. You are better off being as intimately involved in the business aspects as you are in the development aspects of your company.
As I stated in the introduction, this is a high risk venture. The decision to set out independently is a very serious one and should not be taken lightly. While setting up a simple business entity like an LLC or Sole Proprietorship poses little risk on the hobbyists who want a means to promote their work, obtaining financing can place a serious financial burden on the borrower without adequate safeguards and a reliable game product that can generate income.