Completion Bonding for Interactive Title Development

Product development has always been a risky game. Now it is becoming expensive, too. In the last few years, the average cost to develop a new interactive title has passed $1 million and continues to climb. Developers are rarely in the position to finance a project with internal funds, and most publishers are being squeezed by large budgets and reduced shelf space. Banks have traditionally stayed away from financing product development, so the burden has fallen almost entirely on the publishers. This has led to industry consolidation, and a big problem for developers looking to find money to make their next game. It is little wonder, then, that an alternative method for financing new title development has created strong interest in the industry.

The Structure for Completion Bonding

Most development is now undertaken using the "advance royalty" method of financing. The publisher funds the developer on a milestone-to-milestone basis until completion and the developer waits for its big payoff from the much-anticipated stream of dollars coming from sales of the game.

Completion bonding provides an alternative. Adapted from the model long used in the independent film business, completion bonding is paired with bank lending to bring a new source of funds to the industry. The process works like this: the developer and publisher sign a development agreement, as they do now, stipulating a budget and delivery time. The bond company issues a performance bond to both the bank and the publisher that guarantees on-time and on-budget delivery. The bank then funds the developer directly during the development period. Upon delivery of the accepted product, the publisher pays off the bank loan.

The Advantages

Completion bonding brings several advantages to the developer. It puts the developer on a more equal footing in its negotiations with the publisher. This allows the developer to justify higher royalty rates and to present a budget with room for contingencies and a reasonable profit. It gives the developer greater creative control over the project, and it creates a more stable payment stream as payments come from the bank, not the publisher. In addition, it allows the "bonded" developer to stand out from its competitors when approaching publishers for future projects.

Why would a publisher want to use this new financing vehicle? An obvious reason is the guarantee of on-time and on-budget delivery. The publisher's risk during title development is reduced almost to zero. It does not have to pay until an acceptable product is delivered. And because the publisher gets to keep its money until delivery, it gains a much higher return on its investment than the advance royalty model. In addition, it allows the publisher to match revenue and expenses in the same accounting period, thus smoothing the earnings reports to stockholders and investors.

The advantages to the publishers are significant. This is why the developer gains leverage when negotiating new deals. The completion bond model provides a win-win solution.

How Does a Developer Qualify

One of the first questions we are asked by both developers and publishers is how we qualify a developer. Given the widely reported problems with late deliveries and frequent cost overruns, it is a very fair question. In the interest of space, the process can be summarized as an intensive review of three areas: the developer's background, history and experience; the match of the team members with the technical and creative demands of the title; and the management and organizational skills of the developer, including financial condition. Developers are a diverse lot, and each must be viewed on its own merits. A developer with experience in flight sims may not be good at strategy games, so the due diligence process involves quite a bit of subjective analysis.

The qualification process does require a fair amount of paperwork: business plans, resumes, game design documents, technical design documents, etc. For some developers, this is easy because they have all of these things in place. For others, the request for due diligence items may provide the impetus to adopt some business management ideas that can help the business grow. Developers are usually very creative, innovative and independent, but not always the best at running a business. The completion bonding vehicle can provide a structure that helps a developer build a sustainable business.

One of the most important steps to qualify a developer is to visit its office and meet the principals and the team members. An on-site meeting provides a way to understand the individuals behind the resumes, and to see how the team works together. A successful game reflects the dedication and spirit of those who work so long to put it together, and it is not possible to appreciate these talents without talking face-to-face.

Disadvantages and Other Issues

The questions that often come right after how we qualify developers is "how much does it cost", and "who pays for it?" Pricing depends on many factors and will vary from one provider to another, but the range is from 12-16% of the costs of development. This covers the bond fee and the bank charges, including interest. In most instances, the costs of the bond/bank financing are added into the price paid by the publisher upon delivery and are included in the bank loan. Therefore, the developer is not out of pocket for the costs, but does not start earning royalties until the costs are recouped by the publisher.

The completion bond is a guarantee that the developer will perform according to the terms of the development agreement. The bonding company is liable for payment to the bank or publisher should the developer fail to deliver, and will protect against its exposure to loss in case of default and payment of a claim by taking a security interest in the rights to the title and in the assets of the developer. In short, the developer's assets are on the line.

The rights of the bonding company are included here as a "disadvantage," but experience has proven this issue to serve an unexpected purpose. It has motivated the developers to focus and plan more effectively, and to encourage the staff to work hard to meet a goal that is of obvious importance to the welfare of all team members. The bonding model supplies structure to the development process.

The changes in the game industry have created the need for an alternative financing method, and completion bonding is starting to gain favor. It provides significant advantages to both developers and publishers, and brings a needed structure to what has been a relatively unstructured world.