Avoiding Game Development Contract Pitfalls - Royalties

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Here at @Gamelinchpin we like to clear some of the fog surrounding the more complex business of making games.

Negotiating contracts can be tough, and there’s a lot to think about but don’t let some of the most important elements slip you by. Getting these right can make the difference between scraping by and living well and it’s not easy if you lack experience but we’re here to help.

I’ll start by going through some common elements of royalty clauses.

  ** ** I’d like to start out by saying always take professional legal advice before signing a contract, the information below is my opinion only based on experience.

Is it worth it?

YES! There’s a myth that it’s pretty much impossible to achieve royalties on anything but the killer AAA multi-million selling items but I’ve seen many cases where the route to success is often in being aware of what options you have, and what to avoid too.

Common Pitfalls

When thinking about royalties it’s important to really think about all of the different facets of the deal piece together as even the smallest, seemingly irrelevant clause, can mean the difference between making money and losing out completely. Keeping all the different elements balanced is something that comes with experience.

There are a few things to think about but mainly always think about the rate you’re going to recoup the advance at and what you are recouping against as misunderstanding these 2 elements alone can be the ultimate killer.

Recoup Rate

In this section I’m assuming that we’re talking about a typical model where the cash you’re given to make the game (Advance) is recovered, along with other costs, before you start getting any royalties on the profit. This Advance Against Royalties is a common scenario but it can be improved. Think of it as a debt you have to repay.

Now, this bit involves a bit of maths to understand the implications of so I’ll go slowly for you all. :)

Now, typical royalty schemes employ 1 rate that applies through your agreement. In it’s simplest form the publisher takes the money it gets and allocates a portion of that cash to repay the loan they gave you to make the game (Advance). When it’s paid back you get the remainder as royalties.

Lets look at a work example where the royalty rate is 10%, but this obviously varies in real life.

The thing to watch here is the portion of the cash they use to repay your debt (Advance), if this were your royalty rate of 10%, they would need to make 10 times that amount (100% divided by your royalty rate) before your advance is fully repaid and you get royalties.

Now, there’s no reason why the recoup rate cannot be different to the royalty rate. Lets imagine that you now have a recoup rate of 25% and a royalty rate of 10%. Now the publisher only needs to recoup 4 times your Advance before you start seeing royalties at 10%. This is a big difference and really compounds over time.

In a typical contract, the 2 rates are balanced based on how the negotiations with the 2 parties go. I have seen quite a wide variety of values such as:

  • 20% recoup and 30% royalty
  • 10% recoup and 10% royalty
  • 75% recoup and 30% royalty
  • 100% recoup and 5% royalty

I have even seen 1 extreme case where the Advance was written off and a low percentage royalty was paid. In this case the developer saw royalties from day 0.

It is also possible to gain an agreement on hard unit numbers too once you’ve worked out the nitty gritty of all of the parameters. E.g., instead of recouping your Advance at some rate, you start on royalties once your game has sold 100,000 units.

If you can work this out upfront and get the actual number of units down in your contract, then there’s no variance or disagreement later on and quibbling over what is/isn’t recoupable against your advance.

Net Receipts

Before I move on, I need to explain some of the core concepts. I’ll assume you know the difference between Gross and Net but there’s a key phrase typically used in contracts called “Net Receipts” that I’ll try and explain.

Net Receipts refers to actual bit of money left over after everything else has been taken out. This typically includes undefined, variable and uncapped expenses such as Marketing and Retention / Returns.

Marketing budgets are incredibly hard to nail down as they typical depend on prevailing conditions & rates, maybe there’s a competing titles that warrants more of a push for yours, maybe there’s some co-marketing deal being struck. The key here is to try and get as much of this known at the start, there’s should be some value attributed here but try and get this defined or at least try and cap the amount that goes against your royalties.

Retention or Returns These terms refer to the amount of cash the publisher retains to cope with unsold or returned stock. This figure is used to reduce the amount your royalties are calculated against. There’s not a lot you can do about this but be aware that it’s lurking in the background.

The rest of it should be self-explanatory but I’ll happily respond to feedback if I’ve missed a key component.

Currency

This is something that’s often over-looked in our world of global development and is something to consider if you deal with a publisher that holds it’s accounts outside of your territory. It’s worth noting here that some big international companies may not have treasuries in your native country so currency exchange will come into play.

Also, the time between you agreeing the contract and you eventually getting paid some royalties can be a very long time and the financial market changes rapidly.

There’s a couple of things to investigate here: negotiate the fees in the currency that gives you the best deal, in some cases it may not be the one held by the publisher or you.

Secondly, if the time frames and values are considerable then look into Forward Exchange Rates with your bank, where you can get them to agree on a future exchange rate.

What you Recoup against

I’ve explained some of the elements that can massively affect the amount you recoup against. Recouping against undefined Net Receipts is a dangerous game and one you should seek to nail down what the specifics are as above. Be aware of everything you’re getting yourself into.

I’d strongly advice always using a professional company like TC Associates to exercise your right to audit the royalty accounts as pretty much every audit exposes inaccuracies in your favour, sometimes a few thousand and have been known to be millions.

Other Areas to Consider

One other area to consider is how your royalties are recouped against items such as Bundle Deals and how they are affected by any potential retail discounts such as ‘Platinum’ packs.

How will your royalties be affected by different distribution models such as online or retail?

Will you be able to gain any royalties on sales of other items such as downloadable content,  t-shirts, merchandising, social network apps, etc?

What next?

Next Time

In this series I’ll be going exposing another common contract point such as Developer Technology and Intellectual Property.

If you’ve enjoyed this item, please join the conversation in the comments, share this item with friends and subscribe to get the next installment. I’m happy to answer any relevant questions you may have that are posted in the comments.

Further Reading

Entertainment Law Handbook - Sarassin LLP business affairs consultancy for the interactive entertainment industry.

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