Startup and video game law, from a Canadian and U.S. perspective
Video Game Profit Sharing Structures
Our video game studio clients often come to us with plans to split game profits among the team members but require advice on the form this split should take. Three main approaches exist for structuring your video game profit share:
1. Profit Sharing Agreement
The most common approach is the Profit Sharing Agreement. This agreement is between the company and each person participating in the profit share and sets out the profit sharing terms and contains key terms such as:
- How profit is calculated. For example, revenue received by the company from sales of the game minus publisher royalties, platform fees, certain operating costs etc.
- What constitutes the “game”. Does the game include DLC, HD/upscaled/remastered versions, sequels etc.?
- Adjustment of each person’s percentage if future participants added.
- What is the profit sharing duration?
- Is there a cap on payouts?
- Termination upon acquisition of the company or the game, perhaps with a lump payout.
- What happens if the company receives investment?
The benefit to this approach is that the participants are not shareholders in the company and, as a result, do not have a say in how the company is operated or a right to receive payouts from future games developed by the company. However, the parties need to ensure that the agreement is thorough in its scope as any ambiguity or overlooked scenario could create major headaches in the future.
2. Create a Separate Company for each Game
Under this approach, a separate company is created for each game you develop, with the commonality being that the main company you incorporated (the studio) is a majority shareholder (51% and up) in each of these separate companies. For example: Studio Company owns 66 2/3% of Game 1 Company. The separate company would receive profits from the game and distribute them to the shareholders based simply upon their shareholding (although more complex special rights and restrictions could also be put in place). Intellectual property for each game may rest with the separate company or the main company. Profits from the game would be distributed as a dividend to the shareholders.
This approach works well if each person is expecting an interest in the company developing the game with the benefit that these persons cannot participate in future games developed by the main company (which may be unrelated to the current game). However, when pursuing this approach, it is important to obtain tax advice to ensure that distribution of the profits between the companies is structured efficiently.
3. Issue Shares in your Company to Profit Share Participants
Under this approach, a special class of non-voting share (the profit share class) is issued to the profit share participants and contains a dividend right to receive a portion of game profits, which would contain similar terms as described in approach 1 above. This approach is similar to approach 2 above except that no separate company is created. However, additional terms are also required, such as:
- Share retractability: this allows the company to repurchase the profit sharing shares in the future.
- Voting trust: this takes control of some or all of the voting rights of the non-voting shareholders (see non-voting shareholder’s limited voting rights).
The problem with this approach stems from the fact that the profit share participants may only be involved in one game but the studio may continue on to make other games, which the profit share participant should not receive a financial benefit from. Further, by being a shareholder (without detailed share rights and restrictions), the shareholder may be able to participate in profits from future, unrelated titles, benefit from sale of the company and/or exert their rights as a shareholder to participate in the company’s direction. To alleviate these problems, complex terms and agreements are likely needed (see retractability and the voting trust) to ensure that the profit share shareholders only benefit from the game they worked on and have a limited right, if any, to participate in the company’s direction.
As a first step, it’s critical to recognize that your profit sharing agreement needs to be documented in writing. Second, you must reflect on the relationship you desire with the profit sharing participants (duration, scope of their involvement etc.) and analyze that relationship relative to the features of each of the above approaches.