The Most Common Games Developer Fears About Being Acquired…

Do they hold up against what’s happening in today’s games industry M&A deals?

Photo by Harpal Singh on Unsplash

Agnitio Capital we speak with countless developers every month. Over time, we’ve noticed certain patterns. We’re not talking about a taste for Mexican food, shelves full of Funko Pops or a cavalier attitude to shoe wearing in the office. We’re talking about the fears and concerns that most developers share, particularly when it comes to conversations about being acquired.

Agnitio also talks to a great confluence of acquirers and investors on a regular basis. These guys too, have their own rhythms and sensitivities. This is especially true when it comes to the kinds of entrepreneurs they want to back, how they want to provide support and more crucially, how they want to avoid getting too involved.

Every developer has their tale of woe about a partnership that didn’t go well. Age old divisions between so called business people or ‘suits’ and so called creators endure. A certain tribalism has always dogged the medium. From playground debates about which mascot to champion, all the way up to fevered tempers about evil money men. Worn out notions persist in a market where such black and white characterisations have long since ceased to be useful or true.

So where do things stand now? How do the most common fears of games developers stack up against the modern day realities of how acquirers operate? This is our attempt to explore and hopefully provide a useful perspective on exactly that.

This is the monster. It is important to remember that ultimately, making games is an art. A very messy and expensive art but an art nonetheless. Developers understandably feel protective over their creations. Meanwhile, acquirers feel protective over their investments and as such, a natural schism can emerge.

A wise games industry friend of mine once said, “a partner can never create that intangible little moment of magic — but they can sure as hell destroy it”. It’s something that many developers feel intuitively. There is a (probably apocryphal) tale in the games industry about a team that set out to build a football management sim and through the various intrusions of a capricious partner, ended up delivering a greek mythology-themed beat-em-up. Douglas Coupland’s Jpod is a very entertaining read on this subject.

For creatively led studios (particularly those making premium games) the prospect of having someone else dictate what you can make and how you are allowed to make it, is anathema. The prospect of never having to worry about payroll again, paying off the mortgage or maybe even being financially set for life is of course appealing. But what is the day to day operational cost of such prizes to the average developer?

Founded or unfounded?

Losing control of your business is a common, reasonable fear but one that is increasingly outdated in the context of games M&A, at least operationally. There will always be the flavour of acquisition where the acquirer wants to subsume the asset fully into its culture, operations, tech stack and roadmap. Sometimes, that is the right approach (though it is, without exception, ALWAYS painful at the outset).

The kinds of acquirers that have emerged as the most active over the last few years however, often deliberately pursue a strategy of non-integration with the businesses they acquire.

A word about listed acquirers. The continued global success of the games industry has not gone unnoticed by various sources of public capital — both institutional and individual alike. Historically, shareholders in the public markets viewed games companies as “hit-driven” and thus risky. A relatively new breed of listed, acquisitive games company understands this perception. These companies, particularly in Northern Europe, have created investor-friendly vehicles for institutional capital. Think of these as collections of games companies with a broad diversification of value proposition (relating to platform, business model, genre etc.). Meanwhile, they have neither the will nor the resources to force feed culture, portfolio decisions or operational edicts to their acquired studios.

To the acquirer, letting a studio remain “independent” (while offering a serve-yourself smorgasbord of capital, marketing infrastructure, access to further development resources, licenses and more) diversifies and evens-out the revenue streams of the group, increases the opportunity to deliver a hit and spreads the perceived risks to prospective and existing shareholders.

Bottom line — if you are a small, founder-led, profitable studio there are acquirers in today’s market that will pay life-changing sums, and remain more or less hands off.

One of the main reasons many studio founders start a studio in the first place, is to escape corporate life. Everyone has met the EA/Ubisoft/Blizzard Activision veteran who found life at a big corporation about as agile as a vintage printing press. Part of the appeal of starting a company, is often recapturing the speed and excitement you can only experience with a small, hand-picked team.

Developers persistently preempt us with some variation of, “we’re not interesting for an acquirer because we are too small and don’t intend to meaningfully grow headcount.” This point goes double for studios that have chosen purposefully to base their operations in places not typically associated with abundant access to talent.

Founded or unfounded?

It is a myth that in order to be attractive to acquirers your studio has to have some arbitrary number of full-time employees. If InnerSloth announced tomorrow that it was fielding acquisition offers, there isn’t a buyer in the market that would quibble over the fact that it is a team of three.

Neither is it true that an acquirer will only pick up a games company with the expectation that, as one of its internal studios, it will be expected to dramatically scale headcount. Agntio advised Candywriter, a team of thirteen, to sell to Stillfront for nearly $200 million dollars last year. Your size as a studio is a function of how effectively that group can build games that grow revenue.

Indeed, an acquirer will often place a premium on a smaller, more senior team over a more bloated one with a much broader spectrum of talent and experience. On that note, the thing to be careful about, is to limit your company’s reliance on third party contractors where possible. It’s also equally important to know which things really ought to be outsourced.

If your games’ visuals are part of their main appeal, no acquirer will be thrilled to learn that no assets are created in-house. Similarly, if your game is a text-based adventure, no acquirer will regard you as a prudent manager of resources if you have aggressively staffed an internal art department. Pithy examples but the point is, apply focus where it matters and don’t fill headcount quotas — to an astute acquirer they are usually subordinate to other concerns.

Something that developers often ask us about, is how the split between the upfront and earnout components of the deal will work. For the uninitiated, the earnout is simply a mechanism where an acquirer agrees to compensate the seller in the future for likely, but as yet unrealized, enterprise value.

Some developers who have not encountered an earnout structure up close before, quite rightly question the wisdom of selling their company now, if the profit they will earn over the next few years as a private company will be greater than the enterprise value an acquirer will pay for their company today.

Founded or unfounded?

First thing’s first — this seems like a relatively complex area for anyone that doesn’t regularly deal with corporate finance, but honestly, it’s not. Learning the intricacies of C# takes way more brain power.

The earnout component of a deal will typically reflect a company’s point in its lifecycle in relation to the moment when the transaction is closed. Younger high-growth companies that want to sell, will often negotiate larger earnout components to compensate for all of the growth they have yet to unlock. More mature or slower growing companies will look for a bigger upfront component, on the agreed assumption they have less nascent value to be unlocked, post closing. There are a lot of variables that impact where a seller or an acquirer might position the seller on that scale — including to what extent the acquirer will be a catalyst for future growth for specific game titles or of the seller as a whole.

The good news is, at the time of writing (early 2021), many acquirers in this space are very comfortable with sizeable earnout components, sometimes even constituting two thirds of the total consideration. This is great if you have the near-term goal of gaining some liquidity (upfront cash) without giving up the transformative upside you think the company can achieve over the longer term. It is also great where you understand the acquirer’s own strategy for growth and long-term shareholder value. Earnouts are typically based on growth, where the acquirer commits to certain payout mechanisms as a result of different performance thresholds over a given time period (2–3 years is fairly common but there is no rule — you could negotiate a one year and even ten year earnout period if that made sense for your business). It is in the acquirer’s interest to ensure the game, company, sellers and the acquirer itself are all successful long-term.

Small, founder-led teams that control all or most of their business (i.e. they don’t have too many or any external shareholders weighing in on how they should operate/manoeuvre), tend to be very lean beasts. There is precious little operational bandwidth for charging headlong into an M&A sales process and all that that entails. Certainly not without significantly impacting whichever projects the company is working on. Meanwhile it is tempting to go it alone as the prospect of paying a third party to run a process involves putting an enormous amount of trust in someone external to the business.

Founded or unfounded?

With accounts to prepare, KPIs to organize, employment & material contracts to gather, third-party agreements to review, company decks to build, financial models and forecasts to create, data rooms to populate and myriad other tasks, there is no escaping the fact that selling your business is a complex, time-consuming and sometimes stressful process. This is a real issue. It can be made worse when a developer takes this process on solo, goes through the pain of running a process, only to realize that the acquirers they received interest from were more focussed on other deals.

Working with an investment bank does two things: it drastically reduces the operational impact of running a process by absorbing the vast majority of the admin itself. It also focuses the effort on conversations with acquirers that have a higher likelihood of leading to a sale. A good investment bank will work to your timeline and not pressure you into a match you don’t feel comfortable with — especially where that timeline includes some corporate tidy-up to help the company get all of its legal, financial and commercial matters into investor-friendly shape. A conscientious investment bank will spend time getting to know you and your business in detail. They will build a relationship of trust with you and orientate themselves towards the best long-term outcome for everyone. They will foster relationships between you and prospective acquirers, giving time for those bonds to establish. A confident investment bank will not charge upfront or monthly cash retainers.

A common refrain among developers of premium or subscription games is that they feel acquirers are fixated exclusively on free-to-play games and studios. A similar point we hear often is that developers expect an acquirer will pressure them to take their beloved premium IP into the free-to-play realm, post-acquisition.

Many developers we encounter either always disliked the model or became disillusioned with it and decided to pursue non-free-to-play models. Even now, there is toxicity around the topic and there are entrenched positions on both sides. That is a debate for another time, but it’s fair to say that there has never been a more diverse array of monetization approaches available to developers and consumers.

Founded or unfounded?

Free-to-play is by far the dominant source of revenue in the games business — there is at least, no debating that. What is also true is that acquirers in this market see a lot of value in other forms of monetization too. It is definitely not the case that only free-to-play studios can attract M&A attention. We won’t list specific deals here, but we will point you to this article we wrote at the end of last year and invite you to draw your own conclusions.

We are living through a period of intense platform and business model diversification. Smart acquirers are aware of that and how it bodes for the future of the industry. Each case exists on its merits but at Agnitio Capital, acquirers often ask us about premium and subscription developers of every stripe.

A done deal…

There is nothing more patronising than being reassured that your fears are rational. There is also nothing about a gut feeling that can be rationalised away — not fully. Selling your business and forming a partnership is about something fundamentally human and emotional — trust. Agnitio Capital was formed out of a love of games and a desire to help the industry grow. That has broadened over the years to include a profound affection for its makers and a desire to see them succeed.

We have made trust a core part of what we do and the thing about trust is, you can’t manufacture it with facts and insight, such as listed above. Trust takes time to build and given a good partnership must be founded on trust, a good M&A deal should also take time.

The above is a breakdown of what is true and not true, most of the time according to what we at Agnitio see, hear and experience in the course of doing business. But it is also a checklist. The fears we have pointed out should always carry a burden of proof upon the acquirer, and the seller should always be seeking that proof from any and all of its partners. That goes for everything from publishing deals, to M&A transactions, to picking an investment bank to represent them.

We are a games focused investment bank established 17 years ago.