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The End Game: How Top Developers Sold Their Studios - Part Two

Dan Lee Rogers has researched the issues surrounding the sale of independent game developers to larger houses--including the financial terms and interviewing key executives, attorneys, and investment firms to help you understand how to be prepared for any sale you might be involved in. Part 2 concludes the series, and provides insight on how a purcase price is decided upon.

March 5, 2004

25 Min Read

Author: by Dan Lee Rogers

Over the past twelve years more than 60 developer acquisitions have been completed in the video game industry. For most, the parties underwent a process similar to that described in the first segment of this series, where the value of the relationship was evaluated against the needs of each party. In the end, the parties determined that it was in their best interest to move forward, and it was at this point that the real negotiations began.

It is this process that we will discuss in this final article. We will take a closer look at how a developer's monetary value is determined, how the deal is put together, and what can go wrong during the acquisition process. We will conclude by considering what the prospects may hold for you, should you have the opportunity to play The End Game.


You should understand that mergers and acquisitions are complex business relationships that require the help of legal and accounting professionals. The information contained in this article is intended to give you a basic overview of this process as it relates specifically to the interactive video game business. Neither Dan Lee Rogers nor BizDev, Inc. makes any representation or warranty of any kind, whether expressed or implied, with respect to the accuracy or completeness of the information. All information is provided on an "as is" basis, including, but not limited to, warranties of merchantability, non-infringement, or fitness for any particular use.


Once a developer and publisher have decided that they want to proceed with an acquisition, a key component of the process is to determine a selling price for the development studio. While both the buyer and seller use the same variables, their interpretation of the values may be vastly different. And even when a price has been established, the parties must agree on how the deal will be structured, whether as an asset or stock sale, or whether it will be taxable or a tax-free transaction. Because of the implications, both parties employ experienced legal and accounting advisors who evaluate each structure and determine the effect it will have on their client. For both, a major concern is the tax liability.

When determining value, the variables most commonly discussed are as follows:

  • Developer's profit contribution

  • Value of the development team

  • Value of tangible assets (building, computers, and IP)

  • Value of the technology

  • Strategic value

Developer's Profit Contribution

A developer's income (net profit) is a tangible asset that is attractive to publishers, first because it demonstrates the health of the developer; second because that profit, when acquired, directly affects the publisher's bottom line. Through the process of negotiation, a value is assigned to this future cash stream.

Multiple of Earnings

A simple way to determine a developer's income value is by applying a reasonable multiple to their income potential. In other words, if PlayWare, Inc. is earning Y million dollars per year in gross income, then one could argue that given today's standards, they could reasonably ask for Y times X, X being a multiplier that both parties agree is fair. What is fair? According to one source, a 1X multiplier would be the lowest a developer should consider today. But keep in mind that most developers have received many more times than this.

P/E Ratio

If a developer is profitable (and to be a desirable acquisition candidate most are), a value can be determined based on the positive impact the developer's net income will have on the publisher's bottom line. Often this value is determined by using the publisher's P/E ratio as a basis (see insert on previous page). Since the P/E ratio reflects the value stockholders place on the publisher's net income, a percentage of this maximum value can be used to justify the purchase price of a development studio. While this method is used today, it was more popular before pooling-of-interest acquisitions were eliminated. i

Value of the Development Team

Another way to determine a developer's value is by assigning a minimum value to their employees. Using current industry multipliers, a developer's employees are often valued at $100,000-$150,000 each (although one developer told us that $200,000 was a fair price). The reasoning behind this is fairly straightforward: If a publisher were to hire, train, and retain an equally effective employee, how much money would they have to spend to do so? $100-$150K per employee is a fair assessment.

EA's Jerry Bowerman provided a simple explanation, "What does it cost you to recruit, train, and make productive an employee? It's not hard to get a floor value of $100,000 per employee."

While the "average" employee may be valued using this method, certain individuals possess knowledge and know-how that is valued significantly higher, especially if their skills are in demand by the publisher. As an example, an average employee at id Software (makers of Doom and Quake) might be valued at one rate, but cofounder and lead programmer John Carmack's personal value and contribution to the company would certainly be measured altogether differently.

Value of the Technology

Perhaps the most valuable asset (other than people) that a developer brings to the negotiation table is its proprietary technology. When it comes to technology, EA enjoys a position few can duplicate.

"An October 11 acquisition of 30-person Luxoflux is typical. That company has proprietary technology that allows video game coding to be easily replicated to run on alternative gaming platforms. That process has often been quite time-consuming, costly, and bug-ridden." Robert Kotick, CEO Activision

Whether EA buys or builds technology is mostly dependent on timing and cost. If an independent developer can deliver technology that allows EA to take market share from their competitors or to open new markets quicker and safer, then there is a basis for a relationship. EA's acquisition of Black Box is a good example. In just three and one-half years, Black Box was able to start their company, develop core technology, and ship 13 games (two PSX, four PS2, three Xbox, three Gamecube, and one Dreamcast) all of which were top sellers. Clearly, EA felt that technologically something very good was happening at Black Box.

But as we look to the future, some believe that the window of opportunity for technology-based acquisitions is closing, especially given that the technology advances made recently are less obvious to consumers. The message Grand Theft Auto's success sent throughout the industry was that video game sales are not necessarily driven by technology. Accentuating this perception are the advances and stability of middleware. Publishers and a few independent ventures are continuing to invest millions of dollars in engine technology that can be amortized across a broad number of products. If this trend continues, generalized developer software could ultimately lose value.

The Deal

Once the parties have determined that there is mutual interest in an acquisition, a tremendous amount of work must be completed in order to finalize the sale.

Whether it was brought forward by an agent, investment banker, or the publisher themselves; at some point the publisher will present the developer with an offer, which is often done verbally at the conclusion of a series of meetings.

If the developer is interested in moving forward, the publisher creates a letter of intent (LOI). This document, which can be as few as three or as many as fifteen pages, spells out in broad terms what the publisher is prepared to offer. Often, the LOI is preceded by broad verbal agreements on both sides. Nevertheless, rarely is it signed without changes. The LOI summarizes the general terms of the agreement:

  • Structure of the deal (whether purchase of assets, stock exchange, or other)

  • Structure and nature of the compensation (cash, common, and restricted stock)

  • Timing

  • Incentives and performance milestones

Once the LOI is signed it sets in motion a number of activities. On the developer side, a team of attorneys and accounting professionals begin assembling volumes of information requested by the publisher:

  • Verification of asset ownership (property, IP, technology)

  • Verification of employee compensation and employee contracts (non-competes and IP transfer)

  • Verification of income and expenses

  • Verification of debt and liabilities

  • Verification of non-compete agreements and other encumbrances

The developers we spoke with advised others to be prepared in advance for these requests. Attorney David Lee agreed, saying that an important task his firm undertakes is to prepare clients legally and financially for the acquisition process. In the end, everything of substance is contained in the acquisition transaction documents. Lee recommends that a developer should seek counsel as early as possible, since a tremendous amount of work is required to help a developer determine a fair valuation for their company and to ensure that documents, licenses, and other diligence issues are in order.

Two of the biggest mistakes a developer can make are to overstate the value of assets or fail to secure ownership of their IP. If either occurs there is bound to be a price adjustment, since publishers almost always make their offers contingent on clear ownership of property and realistic values.

Simultaneously, the developer's accountants and attorneys are engaged in other equally time consuming tasks:

  • Assessment of a publisher's solvency and projected value of stock

  • Collecting and presenting accounting information

  • Collecting and presenting IP ownership documents

  • Assessing tax implications

  • Developing and presenting counter-proposals based on their findings

Despite the consuming nature of these tasks, a deal can move rather quickly. It is not unusual to have an entire law firm devoted to a purchase, with attorneys specialized in tax, contracts, acquisitions and other areas moving in and out of the deal as necessary.


"The smart publishers know who the good developers are and so there is always that possibility of being in competition. Usually publishers will not want to get into that situation though, for obvious reasons. So there is always sniffing going on, but a publisher will usually try to restrict discussions to just them at some point early on to keep the conversations two- way." Stuart Moulder, General Manager, Microsoft

How long does it can take to complete a deal? Most acquisitions are concluded in as few as two or as many as nine months. Most of the deals we studied took two to three months on average to complete.

Ken Williams, former CEO of Sierra, cautioned that acquisitions that take too long to finalize are less likely to go through. Once a publisher makes a decision to purchase a developer, they want to proceed quickly.


When asked whether offers from a publisher's competitors made a difference in the ultimate price, the answer from most all was "yes". At the same time, both parties cautioned not to over-use this leverage. Most felt that an overly aggressive negotiation could leave bitter feelings, which would be a poor start to a permanent relationship.

In a "humility is strength" posture, developers also advised others to avoid situations where it would be perceived that they were "approaching a publisher" about their interest in being acquired. Like a teenager waiting to be asked to the prom, eagerness ultimately weakens a developer's leverage. David Lee summarized this principle nicely, "Your leverage goes completely the opposite way when you're looking for someone to buy you as opposed to someone knocking on your door."

Publishers agreed. And to the opposite extreme, most avoid entering a bidding war for developers. While there was some flexibility in their price, prior to an acquisition most had already determined what they were willing to pay. Ken Williams looked at it this way, "I preferred to deal without the bankers -- primarily because this meant the deal wasn't being shopped to the high bidder. I had a policy of never being the high bidder."

Publishers are also not attracted to developers who groomed themselves for acquisition. They made it clear that they are only interested in purchasing developers who have made and shipped hit games. Their advice to those wanting to be purchased: Make great games.

The Negotiation

"Honestly, that would put me off. It says that the developer's focus and energies are being diluted by issues outside of the creative and technical realms where their true value lies. If the company is perpetually in "please buy us mode", they are probably making some decisions about their time and money that run in conflict with making an awesome game." Stuart Moulder, General Manager, Microsoft (Regarding developers who groom for acquisition)

Most of the developers we spoke with spent nearly fifty-percent of their time throughout the process in acquisition related activities. Decisions regarding management structure, employee benefits, incentives, and countless other decisions could only be made by them. At the same time, all were represented by experienced attorneys and accounting professionals.

Publishers often have an acquisition team in place or the ability to assemble one quickly. When Sierra was actively involved in acquisitions, their core team consisted of a lead counsel, business development VP (also an attorney), and a VP of business development (whose job it was to provide an integration and transition plan). So busy where they that they had a room at their corporate headquarters in Seattle converted into an "acquisition room" where developer documents were collected and studied.

As information is being collected, the parties engage in a series of negotiation meetings, each designed to find agreement on countless issues. At some point, they find agreement and a final set of documents is prepared.

Final Purchase Document

At the conclusion of a negotiation a final purchase agreement is compiled. This agreement, whether an asset purchase or a stock exchange, is a collection of documents that detail the understanding:

  • Purchase agreement and exhibits:

    • List of assets (mortgages, equipment, etc.)

    • Lease details (office, equipment)

    • Bills of sale

    • IP agreements and ownership

    • Employee agreements and non-compete agreements

    • Transition agreements, including incentive and bonus plans 

What Can Go Wrong?

Not all developer acquisitions have happy endings. Deals based primarily on a publisher's stock can sour if the stock takes a nose dive. Developers we spoke with advised that the stock you receive is only as good as the company behind it.

"Compatibility between cultures and respect for the workings of our culture were very important factors, particularly THQ's desire to leave us to what we do best." Mark DeSimone, Rainbow Studios

On a related note, most developers understand the implications of restricted stock but may neglect to consider that once their company is purchased they become employees of the publisher. As such, they are subject to the same insider trading regulations as other officers in the publishing company. As with all public companies, there are notifications, waiting and black-out periods that can restrict company insiders from selling their stock.

Beyond the financial implications, the parties should carefully consider the other's culture. An acquisition is permanent, and neither party is keen to give up how they conduct business. What is clear, however, is that a continued clash of cultures is a losing proposition for both parties.

For publishers, the value of an acquisition is almost always dependent on the continued involvement of key-employees. If key individuals leave prematurely it causes irreparable harm to both parties. Many of the publishers we talked with could recall developers who had lost interest soon after their acquisition, and their disappointment in these developers was obvious. Microsoft's Stuart Moulder told us that because they know just how important this issue can be, Microsoft invests a considerable amount of time in evaluating the motives of developers before they acquire them.

It is also not uncommon for employees to be resentful when a few individuals reap huge benefits from the sale of the company. This too can cause harm.

On a completely different but important note, it is hard to predict how success may affect someone who has sacrificed and risked much to obtain it. Vance Cook, co-founder of Headgate Studios, talked about this in relation to his partner, who was killed last year in a flying accident. "I've heard several stories of people selling their company, going out and buying sports cars and airplanes, and very quickly meeting their death in them. This wasn't exactly the case with Mark (Mr. Cook's partner), but it is a phenomenon that individuals selling their companies might want to consider." This is a sobering reminder that business success should always be kept in perspective.

The Future

"I don't believe graphics are going to sell games in the future. A lot of the most popular games these days are not the most impressive (graphically), whereas that used to be the case."Jason Rubin, Naughty Dog

With the consolidation that hasrecently occurred in the industry, one wonders how long the window of opportunity for developer acquisitions will remain open. In some respects, with the stabilization of technology, it is becoming more difficult for independent developers to compete on this feature alone. At the same time, it is a mistake to underestimate the creativity and ingeniousness that has propelled this industry from infancy into a multi-billion dollar a year industry.

Publishers made it clear that when they are acquiring a company, they are buying talented people. And we know that creativity, ingenuity, and invention will always be in demand. And as such, there is no end to what independent developers will be able to offer publishers.

Final Notes

We have learned that developers are purchased because they have something tangible to offer: technology and know-how that is superior to the competition and companies that are healthy and driven by a love of the game. When they began, some of the developers who have sold their studios may have had wild dreams of becoming wealthy, but few started their companies solely to get rich. They just wanted to make cool games.

In the long run, what happens after the sale? For Don Mattrick, who sold his company, Distinctive Software, to Electronic Arts in 1991, life is pretty comfortable. Mr. Mattrick is president of Electronic Arts Worldwide Studios and over the course of EA's climb to the top he has enjoyed wealth and success beyond imagination. Few have experienced this level of financial success, but most of the developers we spoke with have benefited greatly from the sale of their company.

Surprisingly, though, what is most apparent is the genuine enthusiasm and love of games that personifies the founders of these successful studios. No doubt it was this love that propelled them to the top of their field. And no doubt it was because of this that their companies were purchased.

Special Thanks

I would like to especially thank the following individuals for their help in creating this series specifically for the Game Developer's Conference 2003:

Jerry Bowerman. Mr. Bowerman began his career as an investment banker in Seattle and San Francisco. Prior to his current position as chief operating officer for Electronic Arts Canada, Mr. Bowerman served as a vice president of Sierra On-Line, where he participated in the acquisitions of Impressions, Papyrus, Headgate Studios, Greenthumb, Pixellite, and others.

Vance Cook. Mr. Cook's background as a lead programmer for Access Software (Links Golf) eventually led him to start his own company, Headgate Studios, which develops some of the best golf games in the world, including Tiger Woods Golf for Electronic Arts. In April 1996 Headgate was purchased by Sierra On-line, and a few years later, Mr. Cook repurchased his technology and company and began developing games as an independent.

Bernard J. Fischbach, Esq. Mr. Fischbach is a member of the board of directors at Acclaim Entertainment. He is a practicing attorney with Fischbach, Perlstein & Lieberman LLP, a law firm specializing in interactive entertainment and the music industries.

Mark DeSimone. Dr. DeSimone is the former president of Rainbow Studios, the creator of several hit games for the PC, PS2, and Xbox, including Motocross Madness, Splashdown, and ATV Off Road Fury. In December 2001 Rainbow was acquired by THQ.

Brian Fargo. As an industry pioneer, Brian Fargo founded Interplay in 1983. In 1995 Interplay acquired Shiny Studios, which was ultimately sold to Atari in 2002. In 2002 Mr. Fargo left Interplay and formed InXile Entertainment in Newport Beach, California.

Vincent Scheure. Mr. Scheure is an associate with Osborne Clarke in London, England. Osborne Clarke is a full-service commercial law firm with over 100 partners and 800+ people based in the City of Londo, Bristol, Reading, Cologne, Frankfurt and San Jose, California.

David Lee. Mr. Lee is a partner with the law firm White & Lee in Menlo Park, California, and has participated in over 200 mergers and acquisitions, including the initial public offerings for QUALCOMM, Wind River Systems and Documentum. He was the lead attorney representing Palm Computing, makers of the successful Palm Pilot family of products, in their merger with U.S. Robotics.

Jamie Leece. Mr. Leece is the former president Gotham Games (a division of Take Two Interactive). Mr. Leece participated in the acquisition of Barking Dog Studios by Take Two, along with various other intellectual property acquisitions made by Take Two during his tenure there.

George Metos. As founder of Sculptured Software and Kodiak Interactive, Mr. Metos' studios have developed some of the best selling games in the world, including Mortal Kombat II and III, Star Wars, Jack Nicklaus Golf, and more. Sculptured Software was acquired by Acclaim in 1995.

Stuart Moulder. As general manager of Microsoft Games Studios, Mr. Moulder participated in the acquisitions of FASA, Digital Anvil, Bungie, and Ensemble Studios. Prior to Microsoft, Mr. Moulder spent four years with Sierra On-Line and seven years prior to that at EDS.

Dave Perry. Mr. Perry is a well known developer and founder Shiny Studios (now part of Atari), creator of Earthworm Jim, MDK, and most recently, The Matrix. His company was originally sold to Interplay in 1995, and then re-sold to Atari in April 2002.

Jason Rubin. Crash Bandicoot and Jak and Daxter creator Jason Rubin has been developing video games since Junior High School, and his company, Naughty Dog is one of the top developers for the Sony PlayStation platform. In 2000 Naughty Dog was purchased by Sony Computer Entertainment of America.

Brett Sperry. Westwood Studios co-founder Brett Sperry sold his company twice, first to Virgin Interactive in 1992, and then to Electronic Arts in 1998. Westwood's title Command and Conquer has been one of the best selling PC games of all time.

Paul Tremblay. Mr. Tremblay is one of the founders of Black Box Games, the creator of several hit games, including Need For Speed Hot Pursuit, NHL Hitz, NHL 2K, and Sega Soccer Slam. Black Box Games was purchased by Electronic Arts in June 2002.

Ken Williams. As founder and former CEO of Sierra On-Line, Mr. Williams has an extensive background in the acquisition of game development studios. During his tenure as CEO, Sierra acquired Dynamix, Impressions, Coktel, Papyrus, Headgate Studios, and many others.

Michael Wallace. Mr. Wallace is a managing director in the technology group of UBS Investment Research and he has covered the multimedia consumer software industry since 1992. In 2002, he was ranked second in stock picking in the leisure category by The Wall Street Journal "Best On The Street" Survey.


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