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Between the global rise of competitive gaming and esports, the
proliferation of mobile and console gaming, and the financial and
cultural success of games such as Fortnite and
Minecraft, it appears little can stop the growth of the
video gaming industry. Having long since overtaken the annual
revenues of the film and music industries, the global video game
market continues to expand at a rapid pace, with consumer spending
on video game products reaching a record $56.9 billion in 2020.
With consumers largely being confined to their homes due to the
COVID-19 pandemic, it is expected that this trend will continue in
2021.
The number of M&A transactions in the video gaming space has
expanded in recent years to keep pace of the growth of the industry
generally, including numerous acquisitions of game development
studios by major platform holders and sales of many smaller and
independent studios to larger development giants. Given the
prevailing positive market trends, many actors both inside and
outside the gaming industry are actively considering entering into
their first video game M&A transaction. However, before
entering into acquisition negotiations or executing a letter of
intent, potential buyers and sellers of video game companies should
understand the industry-specific legal issues that frequently
factor into these transactions to give them the best chance for a
successful deal.
Intellectual Property
IP often comprises the majority of assets held by a gaming
industry company. Relevant IP can consist of the legal ownership
rights to the code, narrative, design and other assets that make up
a game, or the proprietary development tools and trade secrets used
to develop the studio’s titles. Given the high value of this
IP, it is critical that the parties to a gaming M&A transaction
ensure that all relevant IP is actually held by the target and that
its rights in this area are subject to sufficient legal
protections.
Accordingly, prior to entering into a sale process, sellers
should register all valuable IP with relevant government
authorities. As part of its diligence review, a buyer will conduct
IP searches to verity that all seller-developed patents (such as
novel development tools and processes) and trademarks (such as
marks associated with games developed by seller) that drive value
have been properly registered with the US Patent and Trademark
office and that all code associated with software products have
been registered with the US Copyright Office. If you are a seller,
you will want to run your own searches in this area to get ahead of
any potential issues that may derail your sale process. In general,
most IP registration issues can be solved prior to a sale if they
are caught early enough in the negotiation process.
The robustness of a company’s employment and on-boarding
process can also have a dramatic impact on the extent to which a
company’s IP is protected. As industry best practices, sellers
should require all employees (and independent contractors, if
applicable) involved in the development of IP to sign a valid
proprietary information and inventions assignment agreement
assigning all rights to the developed IP to the seller. Sellers
should also ensure that their company’s trade secrets are kept
confidential by requiring all employees to sign confidentiality
agreements during the company’s hiring and on-boarding process.
Buyers should perform extensive diligence in this area and require
that these agreements be executed prior to the closing to the
extent that any relevant employees may have fallen through the
cracks.
A final area of concern with respect to a target’s IP is
open source software (OSS). OSS is commonly used in software
development to quickly implement common functions and to save
developer time. However, the usage of OSS typically requires
acceptance of the terms of that OSS’ license (such as the GNU
General Public License or the MIT License), which can greatly
complicate a sale process. For example, the terms of an OSS license
may contain restrictions on (i) the ways in which the final product
incorporating said OSS code may be commercialized, and (ii) the
ability of the owner of the developed software to keep the source
code for their software private. As a result, buyers will want to
have a firm handle on what, if any, OSS used in the target’s
products and the terms of any relevant licenses. Sellers may
accordingly choose to limit their usage of OSS in their products
and should catalog any existing OSS code (and its accompanying
license) to assist in the buyer’s diligence review.
Employment Issues
The other substantial driver of value in a video game M&A
transaction is the talents of the developers, programmers,
engineers, and other staff employed at the firm. As a result, both
buyers and sellers should pay particular attention to the
target’s business’ employment practices and compliance with
employment law.
In recent years, a number of governmental authorities have
looked to expand the definition of “employee” to include
numerous working arrangements previously classified as
“independent contractor” relationships (California’s
recently enacted AB 5 bill stands as a particularly strong example
of this trend). As an industry that has traditionally relied
heavily on the use of independent contractors, game developers may
be particularly affected by this development. The misclassification
of employees can result in significant tax issues and the
imposition of other penalties. Accordingly, buyers will want to
conduct a thorough review of the target’s classification
process. This review generally requires the application of a
complex multi-factor test, including examining the amount of
control exercised by the target, the location of work, flexibility
of schedule, whether engagement is full time and other factors. You
should engaged skilled employment counsel to assist you in this
specialized review.
Game studios and other businesses in the video game industry
often grant their employees stock options as part of their
compensation packages. Special care must thus be taken as part of
your deal to ensure that existing employee stock options are
adequately dealt with as part of the closing. either by paying off
and cancelling existing stock options or by having the buyer assume
the existing options. Both the buyer and seller will want to
carefully review the target’s existing stock option plan
documents to ensure any cancellation or assumption of the plan is
compliant with the plan’s requirements. As part of the deal,
the parties must also determine the extent to which stock option
holders will participate in the sellers’ post-closing
indemnification obligations to the buyer, and, if applicable, any
“earn-out” contingent payments earned after the
closing.
The topic of “crunch” in game development studios has
also become a hot topic in recent years, with many prominent
developers promising to reduce the duration and frequency of crunch
periods during game development. The increased number of employee
overtime hours associated with crunch introduce a number of
potential employment law issues that must be examined closely by
sellers and buyers. Failure to appropriately compensate employees
for overtime hours worked can lead to substantial statutory
penalties and potential class action lawsuits, which may prove
fatal to an M&A transaction if not preemptively addressed.
Special employment issues present themselves in video game
M&A transactions where talent acquisition is a major driving
force behind the buyer’s interest. In these deals, care must be
taken by the buyer to provide acquired employees with adequate
incentive to remain at the target post-transaction and ensure that
you do not overpay for the target if they ultimately leave. Buyers
and sellers can generally collaborate on deal structuring to solve
these issues. For example, part of the purchase price may be
subject to an earnout that is only paid if the key employees remain
with the target for negotiated period following the closing. Buyers
may also want to consider issuing new equity options to these
employees to incentivize them to remain with the business during
the applicable vesting period.
Contractual Issues
Video games are seldom developed in a vacuum. Publishers,
middleware and game engine distributors, asset creators, and
platform holders all frequently contribute to the final game that
is sold at retail. Each of these relationships is governed by
contractual arrangements that must be reviewed during the due
diligence process of an M&A transaction to confirm business
terms and to ensure that the transaction does not violate the terms
of any critical contracts or raise other legal issues. As discussed
above, it is essential to review all contracts with third parties
that involve the acquisition or licensing of assets or code for use
in a final game to ensure that the proper licenses are granted and
that the transaction will not violate any key licenses previously
granted.
Seller’s contracts with parties not directly related to game
development (such as the seller’s leases, agreements with
vendors, and loan documents) should also be reviewed by legal
counsel to determine if, among other things, these agreements (i)
are enforceable and in-effect as of the day of the transaction,
(ii) are subject to commercially reasonable terms, (iii) are
assignable to buyer in the transaction, and (iv) contain provisions
or requirements that could delay or prevent the M&A transaction
from occurring. If your transaction is to be structured as an asset
sale, the parties should work together to discuss which of these
contracts will be assigned to the buyer at the closing.
Regulatory Compliance
Data collection and storage is a vital part of the game
development and maintenance process, as user data provides game
developers with critical feedback regarding feature usage, bugs,
and game balance. However, the collection of user data is subject
to increasingly complex rules and regulations, which differ on a
state-by-state and nation-by-nation basis and need to be reviewed
as part of your transaction.
The European Union’s General Data Protection Regulation law,
which went into effect in 2018, dramatically increased the security
and privacy obligations data collectors have regarding data
collected from EU citizens. California’s recently-enacted
California Privacy Act seeks to do the same for data collected from
California residents. Parties in video game M&A transactions
should confirm that the target is in compliance with all relevant
data collection privacy laws to avoid any post-closing liability
for applicable violations.
Governmental regulatory agencies across the globe have
increasingly expressed interest in regulating “lootboxes”
and other in-game monetization practices, especially those found in
games targeted towards children. Belgium has taken a heavy-handed
approach to the regulation of lootboxes, requiring developers to
restrict access or remove these features from their titles in that
region, while other nations, such as the United Kingdom, appear to
be taking affirmative steps to enact a new regulatory framework
governing in-game microtransactions. While the consequences for
noncompliance with these new regulatory regimes are largely
untested, targets employing these practices should closely monitor
changes in relevant regulatory bodies to ensure that their products
comply with local law as they could raise issues for your deal.
Conclusion
M&A transactions in the video gaming industry should remain
robust for the foreseeable future. However, these deals require
that special consideration be paid to certain areas of potential
risk that are not present in transactions in other industries. To
help ensure your interests are adequately protected, we recommend
that you engage the services of a seasoned deal team of
professional advisors (including dedicated M&A counsel) who are
experienced in these transactions to help you navigate potential
pitfalls. By approaching your sale process in a deliberate and
informed manner, you will give yourself the greatest chance of a
successful closing.
Originally Published by International Game Developers
Association., March 2021
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
.
To print this article, all you need is to be registered or login on Mondaq.com.
Between the global rise of competitive gaming and esports, the
proliferation of mobile and console gaming, and the financial and
cultural success of games such as Fortnite and
Minecraft, it appears little can stop the growth of the
video gaming industry. Having long since overtaken the annual
revenues of the film and music industries, the global video game
market continues to expand at a rapid pace, with consumer spending
on video game products reaching a record $56.9 billion in 2020.
With consumers largely being confined to their homes due to the
COVID-19 pandemic, it is expected that this trend will continue in
2021.
The number of M&A transactions in the video gaming space has
expanded in recent years to keep pace of the growth of the industry
generally, including numerous acquisitions of game development
studios by major platform holders and sales of many smaller and
independent studios to larger development giants. Given the
prevailing positive market trends, many actors both inside and
outside the gaming industry are actively considering entering into
their first video game M&A transaction. However, before
entering into acquisition negotiations or executing a letter of
intent, potential buyers and sellers of video game companies should
understand the industry-specific legal issues that frequently
factor into these transactions to give them the best chance for a
successful deal.
Intellectual Property
IP often comprises the majority of assets held by a gaming
industry company. Relevant IP can consist of the legal ownership
rights to the code, narrative, design and other assets that make up
a game, or the proprietary development tools and trade secrets used
to develop the studio’s titles. Given the high value of this
IP, it is critical that the parties to a gaming M&A transaction
ensure that all relevant IP is actually held by the target and that
its rights in this area are subject to sufficient legal
protections.
Accordingly, prior to entering into a sale process, sellers
should register all valuable IP with relevant government
authorities. As part of its diligence review, a buyer will conduct
IP searches to verity that all seller-developed patents (such as
novel development tools and processes) and trademarks (such as
marks associated with games developed by seller) that drive value
have been properly registered with the US Patent and Trademark
office and that all code associated with software products have
been registered with the US Copyright Office. If you are a seller,
you will want to run your own searches in this area to get ahead of
any potential issues that may derail your sale process. In general,
most IP registration issues can be solved prior to a sale if they
are caught early enough in the negotiation process.
The robustness of a company’s employment and on-boarding
process can also have a dramatic impact on the extent to which a
company’s IP is protected. As industry best practices, sellers
should require all employees (and independent contractors, if
applicable) involved in the development of IP to sign a valid
proprietary information and inventions assignment agreement
assigning all rights to the developed IP to the seller. Sellers
should also ensure that their company’s trade secrets are kept
confidential by requiring all employees to sign confidentiality
agreements during the company’s hiring and on-boarding process.
Buyers should perform extensive diligence in this area and require
that these agreements be executed prior to the closing to the
extent that any relevant employees may have fallen through the
cracks.
A final area of concern with respect to a target’s IP is
open source software (OSS). OSS is commonly used in software
development to quickly implement common functions and to save
developer time. However, the usage of OSS typically requires
acceptance of the terms of that OSS’ license (such as the GNU
General Public License or the MIT License), which can greatly
complicate a sale process. For example, the terms of an OSS license
may contain restrictions on (i) the ways in which the final product
incorporating said OSS code may be commercialized, and (ii) the
ability of the owner of the developed software to keep the source
code for their software private. As a result, buyers will want to
have a firm handle on what, if any, OSS used in the target’s
products and the terms of any relevant licenses. Sellers may
accordingly choose to limit their usage of OSS in their products
and should catalog any existing OSS code (and its accompanying
license) to assist in the buyer’s diligence review.
Employment Issues
The other substantial driver of value in a video game M&A
transaction is the talents of the developers, programmers,
engineers, and other staff employed at the firm. As a result, both
buyers and sellers should pay particular attention to the
target’s business’ employment practices and compliance with
employment law.
In recent years, a number of governmental authorities have
looked to expand the definition of “employee” to include
numerous working arrangements previously classified as
“independent contractor” relationships (California’s
recently enacted AB 5 bill stands as a particularly strong example
of this trend). As an industry that has traditionally relied
heavily on the use of independent contractors, game developers may
be particularly affected by this development. The misclassification
of employees can result in significant tax issues and the
imposition of other penalties. Accordingly, buyers will want to
conduct a thorough review of the target’s classification
process. This review generally requires the application of a
complex multi-factor test, including examining the amount of
control exercised by the target, the location of work, flexibility
of schedule, whether engagement is full time and other factors. You
should engaged skilled employment counsel to assist you in this
specialized review.
Game studios and other businesses in the video game industry
often grant their employees stock options as part of their
compensation packages. Special care must thus be taken as part of
your deal to ensure that existing employee stock options are
adequately dealt with as part of the closing. either by paying off
and cancelling existing stock options or by having the buyer assume
the existing options. Both the buyer and seller will want to
carefully review the target’s existing stock option plan
documents to ensure any cancellation or assumption of the plan is
compliant with the plan’s requirements. As part of the deal,
the parties must also determine the extent to which stock option
holders will participate in the sellers’ post-closing
indemnification obligations to the buyer, and, if applicable, any
“earn-out” contingent payments earned after the
closing.
The topic of “crunch” in game development studios has
also become a hot topic in recent years, with many prominent
developers promising to reduce the duration and frequency of crunch
periods during game development. The increased number of employee
overtime hours associated with crunch introduce a number of
potential employment law issues that must be examined closely by
sellers and buyers. Failure to appropriately compensate employees
for overtime hours worked can lead to substantial statutory
penalties and potential class action lawsuits, which may prove
fatal to an M&A transaction if not preemptively addressed.
Special employment issues present themselves in video game
M&A transactions where talent acquisition is a major driving
force behind the buyer’s interest. In these deals, care must be
taken by the buyer to provide acquired employees with adequate
incentive to remain at the target post-transaction and ensure that
you do not overpay for the target if they ultimately leave. Buyers
and sellers can generally collaborate on deal structuring to solve
these issues. For example, part of the purchase price may be
subject to an earnout that is only paid if the key employees remain
with the target for negotiated period following the closing. Buyers
may also want to consider issuing new equity options to these
employees to incentivize them to remain with the business during
the applicable vesting period.
Contractual Issues
Video games are seldom developed in a vacuum. Publishers,
middleware and game engine distributors, asset creators, and
platform holders all frequently contribute to the final game that
is sold at retail. Each of these relationships is governed by
contractual arrangements that must be reviewed during the due
diligence process of an M&A transaction to confirm business
terms and to ensure that the transaction does not violate the terms
of any critical contracts or raise other legal issues. As discussed
above, it is essential to review all contracts with third parties
that involve the acquisition or licensing of assets or code for use
in a final game to ensure that the proper licenses are granted and
that the transaction will not violate any key licenses previously
granted.
Seller’s contracts with parties not directly related to game
development (such as the seller’s leases, agreements with
vendors, and loan documents) should also be reviewed by legal
counsel to determine if, among other things, these agreements (i)
are enforceable and in-effect as of the day of the transaction,
(ii) are subject to commercially reasonable terms, (iii) are
assignable to buyer in the transaction, and (iv) contain provisions
or requirements that could delay or prevent the M&A transaction
from occurring. If your transaction is to be structured as an asset
sale, the parties should work together to discuss which of these
contracts will be assigned to the buyer at the closing.
Regulatory Compliance
Data collection and storage is a vital part of the game
development and maintenance process, as user data provides game
developers with critical feedback regarding feature usage, bugs,
and game balance. However, the collection of user data is subject
to increasingly complex rules and regulations, which differ on a
state-by-state and nation-by-nation basis and need to be reviewed
as part of your transaction.
The European Union’s General Data Protection Regulation law,
which went into effect in 2018, dramatically increased the security
and privacy obligations data collectors have regarding data
collected from EU citizens. California’s recently-enacted
California Privacy Act seeks to do the same for data collected from
California residents. Parties in video game M&A transactions
should confirm that the target is in compliance with all relevant
data collection privacy laws to avoid any post-closing liability
for applicable violations.
Governmental regulatory agencies across the globe have
increasingly expressed interest in regulating “lootboxes”
and other in-game monetization practices, especially those found in
games targeted towards children. Belgium has taken a heavy-handed
approach to the regulation of lootboxes, requiring developers to
restrict access or remove these features from their titles in that
region, while other nations, such as the United Kingdom, appear to
be taking affirmative steps to enact a new regulatory framework
governing in-game microtransactions. While the consequences for
noncompliance with these new regulatory regimes are largely
untested, targets employing these practices should closely monitor
changes in relevant regulatory bodies to ensure that their products
comply with local law as they could raise issues for your deal.
Conclusion
M&A transactions in the video gaming industry should remain
robust for the foreseeable future. However, these deals require
that special consideration be paid to certain areas of potential
risk that are not present in transactions in other industries. To
help ensure your interests are adequately protected, we recommend
that you engage the services of a seasoned deal team of
professional advisors (including dedicated M&A counsel) who are
experienced in these transactions to help you navigate potential
pitfalls. By approaching your sale process in a deliberate and
informed manner, you will give yourself the greatest chance of a
successful closing.
Originally Published by International Game Developers
Association., March 2021
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
. — to www.mondaq.com
