Work for Hire Publishing Agreement

Property

If the contract is a work for hire, this section is where the publisher describes the content intellectual property with which you will be working (such as "Spiderman"). It is important to carefully understand the "four corners" (the boundaries) of the property, because one property can have many different incarnations, only some of which the publisher is licensing. Example: the recent Spiderman game would use assets and story lines from the recent Spiderman film, not from the live-action Spiderman TV show of the early eighties.

Additions to the property

Frequently, the licensor will include language stating that any additions a licensee makes (say, a new weapon) are granted back to the owner and become part of the property; other times, the licensor will co-own additions with the creator.

Term

The term defines the duration of the parties' different rights. Terms are usually broken out into Initial Terms and Renewal Terms . The initial term covers development and commercial release of the game, and the renewal term kicks in if the relationship meets certain conditions, for example, if the game is successful and the parties develop a sequel together. Term considerations are discussed more fully in the section below on Developer-owned IP Publishing Contracts.

Territory

Territory determines the area for which a publisher is purchasing rights. In a work for hire, the publisher will most likely take a worldwide exclusive license, in other words, the right to manufacture and distribute the game worldwide. However, if you are extremely enterprising and want to pursue distribution in areas the publisher does not, you will want to negotiate either to keep rights to territories for which the publisher has no release plans, or for a territory-by-territory reversion (rights that are granted return to the grantor) if the publisher is not distributing product in the given territory.

Development Fees

A standard compensation arrangement will be broken out into two or more tiers, depending on whether it is your IP being licensed or you are doing a work-for-hire. The first tier is the development fee/advance against royalties, paid out over the duration of development; the second tier is royalties after earn-out (defined in Royalties, this section); and the third is ancillary products revenue , money earned from the sale of merchandise related to the game like strategy guides.

Tier One: Development Fee/Advance Against Royalties

The first tier is the development fee/advance against royalties. This is what you will receive over the period of development to cover costs. You will want to be sure that the development advance is non-refundable. The typical structure is 20 percent at signature, 10 percent at gold master, and the remaining 70 percent spread out over ten or so milestones. No milestone = no milestone payment, so schedule yourself realistically or you'll end up late and lacking the money necessary to complete the milestone. Don't assume that the publisher will jump in with more money to protect its investment: Sometimes a publisher will see this as throwing good money after bad and will terminate the project; other times, it may require additional compensation in exchange for additional funding.

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To protect yourself, assume that the pub lisher will not pay milestones in a time ly manner and build a cash cushion suffi cient to weather sig nificant delays.

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Be extremely careful when budgeting and pricing your development contract. Many developers add a margin to their budgets and end up spending all the padding and never receiving royalties. Remember: odds are very high that you will not receive any royalties on a game, so plan accord ingly and be willing to cut features to stay on time and within budget.

Tier Two: Royalties

Royalties are a percentage of the publisher's sales payable to you. The balls to keep your eye on when discussing royalties are

• Recouping/Earn-out process. How much money the publisher must earn before it begins sharing royalties with you.

• Cross-collateralization. Whether the publisher can apply revenues from one SKU to the costs of another. Example: can the publisher use your share of ancillary products revenue to recover costs of developing the game?

• Royalty rates for each category. The percentage you will receive for different platforms, products, and methods of distribution.

• Definitions of "Gross" and "Net." How big (or small) is the pie you'll be getting a slice of.

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It is wise to have the pub lisher include a sample roy alty statement as an appen dix to the contract, and be sure it includes the number of units manufactured, the number sold, and the whole sale price. A sample royalty statement is included at the end of this chapter.

Recouping

The publishing company will want to "recoup" some or all of the development fee from royalties payable on the game (or other productssee the discussion of cross-collateralization in this section) before it begins making royalty payments to you. Earn-out the point at which the publisher begins paying royalties.

The three main schemes for recouping the development fee are

1. Recouping the fee from net sales at developer's royalty rate (most favorable to the publisher)

2. Recouping the fee from total net sales (most favorable to you)

3. Recouping the fee from net sales at developer's royalty rate minus X percent and paying developer X percent from unit one (a valid compromise, but a very uncommon arrangement)

Here's an amusingly lowball example: Assume the royalty rate is 10 percent of net sales, the publisher makes $10 in net sales per unit, and the development fee was $100,000. $1 (10 percent of $10) of every unit sold goes toward repaying the development fee; you will begin receiving royalties after sales of 100,000 units (barring other income from ancillary products). You won't like this setup since the publisher would break even and be long into the black before sharing any money with you.

You will want the publisher to begin paying royalties after break-even , once net sales (see discussion below) exceed the development fee (in other words 10,000 units).

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When negotiating, you should expect a trade-off between the advance and the royalty rate. If your advance is higher, your royalty rate will be lower, and vice versa.There is a risk balance between you and the publisher: up-front money is high risk for the publisher, low risk for the developer; back-end com pensation is the reverse. Some developers with a cash cushion and confidence in their product prefer the higher royalty rate, assuming they can negotiate a favorable definition of net sales; many other developers prefer the lower risk, guaranteed return, and ready money of the higher advance. Take a look at the expected release window: is the game going out during the competitive, but lucrative Christmas season ? Or will it be part of the dreaded August release? A low royalty rate not only means that you will ultimately earn less revenue, you will also have to sell more units to recoup.

Another approach may be available in situations of lower risk to the publisher (such as where you have self-funded or partially- funded ) that will not increase your ultimate revenue but does reduce your risk and provide more even cash flow. You can negotiate for a proportion of the royalty from unit one to go toward repaying the development fee and the rest to be paid to you currently. Using the above example, if the developer negotiates to receive 25 percent of its royalty rate starting with unit one sales, then $.75 of every unit sold would go toward recoupment, and $.25 would go to the developer until unit 133,334, at which point the developer would receive $1 from every unit. So the earn-out is pushed back, but the developer will still earn some royalties even if the game sells only 100,000 units.

Cross-Collateralization

Cross-collateralization means that the publisher can recoup development advances from more than one SKU (retail term meaning "stock-keeping unit;" each platform is considered a separate SKU) or category. Some publishers will want to cross-collateralize every revenue stream from you against every contract it has with you. So, for instance, royalties from a game done with a publisher now can be withheld to repay any unrecouped advances from a contract ten years earlier. You will want to keep the fictional third party in mind when arguing for limiting cross collateralization to:

• Platform by platform, so that a profitable Xbox SKU will not be used to subsidize an unprofitable Gamecube SKU, and the U.S. release will not be cross-collateralized with the Chinese localization.

• Simultaneous releases, for example sequels, will not be cross-collateralized against the original.

• Games only. In other words, the publisher cannot cross-collateralize across categories like ancillary products or revenue from the licensing developer's IP, whether technology or entertainment (other media, such as a film or soundtrack, based on the same property).

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A developer can resist platform by platform cross-collateralization by arguing that if a third party developed the port or localization, the publisher would not be able to wait to pay roy alties until it had recouped develop ment fees for the original game.

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A developer can argue that if a third party developed the sequel, the publisher would not be able to wait to pay royalties to that third party until the publisher recouped development fees for the original game.

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This is crucial when you own the content intellectual property. You can resist cross-collateralization from entertainment based on your IP by arguing that if the publisher had purchased, for example, film rights from a third party, it would not be able to withhold royalties from that licensor until the publisher had recouped development fees.

If, for instance, a publisher purchases the rights to make games and other entertainment based on a popular card RPG and then sublicenses the right to make a film to a third party, the publisher will most likely have to share revenue with the card RPG licensor from the first dollar that the publisher receives from the film producer. The publisher would probably not be able to recoup its game development costs before pay ing the card RPG licensor for film-related revenue. Therefore, when the developer is also the licensor, the publisher will be no worse off than if it had licensed the property from a third party (like a card RPG licensor) if it does not recoup development costs before paying license revenues to the developer. For more on this topic, see Chapter 7 : " Licensing ."

Royalty Rates

The royalty rate paid to a developer varies significantly based on reputation, platform, whether it is developing its own content, and the size and leverage of the publisher. Some publishers like to grant a flat amount per unit sold, which can put your heart at ease over accounting chicanery (see net sales discussion, below), but the percentage of net sales is more common. Wherever the

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Given the hit-driven nature of the game business, be prepared for your publisher to actually try to reduce the royalty rate as sales go up, with the reasoning that 1) the developer is incurring no additional cost and is mak ing a fair return even at a lower royalty rate, and 2) hits are what keep publishers in business so they need to capture as much revenue as possi ble from the hits in order to finance the games that fail.Your response to this should be 1) that a developer's business model relies on extra revenue from hits to cover the games that never earn-out, and 2) the publisher's share of net sales is already significant enough to cover its risk.

Example:

Consoles

8-20% 1-300/500k

10-22% 3/500-750/1mm

12-24% 750/1mm - 1mm/1.5mm

14-26% 1.5mm and up

PC

Some developers argue that they should receive a higher royalty for PC games because the publisher does not have to pay any license fees to the console manufacturer.

Handheld

5-8%

PDA and Wireless

This area is still developing, but the developer should receive a share of any revenue generated by PDA or wireless game distribution.

Online Multiplayer, Digital Distribution, and Subscriptions

This area is still developing, but developers should receive a share of revenue generated by subscription services using their content. Developers are arguing that they should receive higher royalties for digital distribution of games given the reduced cost of distribution.

Ancillary Products

25-50% of Net Sales or Net Receipts (see sections in this chapter)

Entertainment

25-60% of Net Receipts (see section in this chapter)

The publisher will want to reduce royalty rates in the following situations:

• The wholesale price drops below a price point specified in the contract [expect no royalties for units given away or sold at less than the publisher's actual cost of goods sold ("COGS")].

• For follow-on games developed by a third party.

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You will, in effect, receive a lower royalty rate for games sublicensed for publication by third parties ( generally in territories where the publisher does not have a strong network) because the publisher will itself be receiving a royalty from the third- party publisher, leaving the developer with the same slice of a smaller pie. (See Sidebar: It's Not Really a Small World, After All ). You may want to handle this by having two royalty structures, one for mar kets in which the publisher distributes the product and another for markets where the publisher sublicenses the product.

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Keep the cost of sublicensing in mind when selecting a publisher and negotiating the territory of a contract. It may not make sense to grant worldwide rights to a pub lisher with distribution in North America only.

Definitions of Gross and Net Sales

The publisher will want to deduct certain expenses from revenue received in connection with the game (or licensing products and entertainment). Just as the publisher recoups its cash outlays for development of the game, it will want to recoup certain cash outlays for selling the game. Which of these outlays are fair to recoup and which are not is the subject of negotiation between parties. Getting from "gross" to "net" refers to the set of expenses deducted to arrive at the royalty base , the number from which you will receive your royalty percentage.

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This is one of the most important sections of the contract. If you get a great royalty rate, but neglect to pay attention to the deduc tions allowed, you will make significantly less money than had you received a lower rate on a higher base.

Gross Sales

For games you will want the gross to include all games sold and not returned. For entertainment/merchandise you will want the gross to include all licensing fees and revenues received by the publisher, its subsidiaries, partners , affiliates , and sublicensees, including barter. The interrelation of entertainment conglomerates makes the cast of Deliverance look like models of genetic hygiene. Including the value of barter will prevent situations where, for example, the publisher receives millions of dollars in advertising time on the network that happens to own the production company that licensed the live action TV show rights to your game.

Net Sales

The publisher will want to deduct as much as possible from gross sales to get to net, because this minimizes payable royalties. Of course, you want to limit the deductions to non-overhead cash expenditures actually paid to unaffiliated third parties. The core deductions are: reserves , credits, returns, mark downs , lost and damaged goods, write-offs, allowances, promotional units, and rebates.

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Where the publisher will be sublicens ing game production to another pub lisher (in another territory, for instance), most of the deductions listed here will already be taken out of the royalty received by the publisher and should not be deducted again from the publisher's receipts. (See Sidebar: It's Not Such a Small World, After All .)

• Credits. Refunds issued by the publisher to the distributor.

• Return reserve allowance of 10 to 20 percent (liquidated after two periods or 180 days, whichever is shorter). When a publisher sells product to a distributor, some of the product usually comes back if it doesn't sell through in retail. However, a publisher does not know what portion will come back until some time later, usually a few months. To protect against paying a royalty to you for items that are later returned, the publisher will maintain a return reserve allowance . Essentially , the publisher will set aside 20 percent of the revenue from a given period and not pay royalties on it until enough time has elapsed that the publisher is comfortable that any returns from that period have come back. Example: A publisher who maintains a 20 percent return reserve allowance for 120 days sells 100 games to the distributor in January. It will pay you royalties on 80 games. Four months later, the publisher will look to see how many of the games sold in January have been returned. If only five games were returned, the publisher will liquidate the January reserve and pay you royalties on the allowance less actual returns (20-5=15).

• Returns. If, on the other hand, the number of returns exceeds the allowance, the publisher will want to deduct those units from any royalties it may owe.

• A commercially reasonable number of promotional units/rebates. Publishers will send out a certain number of free copies of the gameto the press, to retailers and distribu -tors, anyone it wants to sell the gameto help market the game. Sometimes a rebate will be offered on sales of the game. A developer will want some kind of a cap on the number of promotional units a publisher can give away.

• Lost and damaged goods and write-offs.

A publisher may want to add on other deductions for

• Cooperative advertising and MDF funds. Cooperative advertising is funded by several groups in an industry to advertise together. MDF is short for market development funds, which is money paid to retailers to secure shelf space, end caps (the high-visibility displays at the ends of aisles ), and advertising (in circulars, for example).

• Cost of goods sold. All costs that the publisher puts into the finished product, from manufacturing to packaging and license fees.

• Manufacturer's platform royalties. The publisher must pay a royalty to the owner of proprietary platforms (like Sony for the PS2 or Nintendo for the GameBoy) for every game sold. This is how console manufacturers earn their profitsthey generally lose money on the R&D and manufacture of the consoles, but make money through the royalties publishers pay to create games for the platform.

• Price of name talent in association with a licensed property. If your company is doing a licensed game for a movie, for example, and the publisher insists that you use the voices of the film's actors, the publisher will want that to be considered a development cost.

• Sales taxes and VAT. VAT is value-added tax , a tax imposed by many countries on all finished goods. Some people think it's how Canada prevents more Americans from moving there.

• Shipping charges. If these are included, a developer will at least want to limit the deduction to charges actually paid to unaffiliated third parties (alternatively, limit shipping and handling not to exceed $ X ).

• Imputed fees for publisher assets and services. If a publisher wants to use its own assets to further the game, whether in-house attorneys and licensing staff to an engine, it may want to charge you an imputed fee for these items. Imputed means that there is no itemizable cost to point to, but there is value being exchanged that should be recognized and compensated.

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A developer's strongest argument against most of these expenses is that they are the publisher's overhead and that all overhead is covered by the (100 percent-developer's royalty) per centage the publisher receives. Shared deductions are intended to protect the publisher against its actual risks and costs associated with your game.You may want to try and limit the amount of these expenditures by requiring the publisher to provide you with timely documentation of the money spent.

Sequels

Sequels are closely related to any discussion of the term because they act as extensions. Sequel rights can prolong a relationship, so it is wise to build in assurances that the extension will benefit both parties. In a work for hire, the sequel rights at issue are usually for the right to be the development house on any sequels. This is usually included as a right of first negotia tion or a right of last refusal . If the original developer does not want to work on the sequel, the publisher may want some kind of follow-up support for any third-party developers.

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Create a cap, whether in hours or otherwise, on the amount and kind of support provided.

Right of First Negotiation and Right of Last Refusal

These rights are essentially what they sound like: the right to be the first party negotiated with and the right to be presented with and have the opportunity to match the final offer from all other parties.

It doesn't make much sense to negotiate the terms of a sequel development deal before the initial game is even complete, especially since gaming hardware changes so much and long-term contracts can saddle you with obligations that become impractical , if not impossible . Beyond the usual language of "will negotiate in good faith," developers are usually granted a right of first negotiation. This means that the publisher must negotiate with you for a certain period (usually 30 days) to develop the project. If you and your publisher cannot come to an agreement for the sequel, the publisher may pursue another developer, but may not cut a deal with that developer that is any sweeter than the one offered to you.

The right of last refusal states that any agreement the publisher comes to with a third party must be offered back to you for X number of days before the publisher proceeds with that third party.

While these rights seem innocuous enough, they can bite in two ways: delay and chilling negotiations with outsiders. A right of first negotiation must expire before the parties can look elsewhere, causing a delay of at least thirty days should no agreement be made. A right of last refusal hanging over a property will make third parties wary of negotiating, since they know that their terms will be shopped back to the last refusal rights holder.

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The right of last refusal is a bit more airtight that the right of first negotia tion, because definitions of "sweeter" vary; example: if the second develop er's contract gives it a higher develop ment fee but a lower royalty and no sequel rights, is that a sweeter deal?

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Notice is very important for follow-on developments.Timing cash flow and resource commitment is everything to a developer, so you will want to do everything you can to avoid a situation where you need work to begin as soon as possible on a sequel when you have just committed a team to another project.The best way to work this out is to agree on a notice "deadline," perhaps 90 days following the initial commercial release of the game, during which the publisher can interpret the sales data and decide if it wants to do a sequel. Another option is for the pub lisher to give you a heads-up period (90 days, for example) that would enable you to organize resources for the project. Do beware: many pub lishers are nervous about the reliability and functionality of rapidly staffed teams and may shy away from the latter scenario.

Development Procedures

The contract should specify not just what you will be delivering (milestones), but how you will be delivering it, how it will be accepted, what changes to the milestones are acceptable, and what happens when milestones are late. Will the publisher be delivering any development kits? At whose expense (usually the publisher's) and when? (Tardy development kits can lead to missed milestones.) The first milestone should be signing the short form contract, and the last is usually delivery of the gold master. As for pricing the contract, you will want to factor in as wide a margin of error as possible and to isolate as many unpredictable costs (cost of third-party licenses, name actors or vocal talent required by the publisher or over which the publisher has approval, and any other costs over which you have no control) by stating that the milestone advance amounts will be $Xplus the cost of those items to be jointly approved, or that the publisher will cover those costs for all publisher- mandated content. Remember when drafting the milestone schedule: publishers who need to deliver products in very particular retail or quarterly income windows prize a developer with a reputation for being on time.

Milestone Definitions

While the nature of game development means that milestone definitions must be somewhat elastic, many developers and publishers cite lack of clarity in milestone definitions (and the resulting mismatched expectations) as a common cause of friction.

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To improve the quality of mile stone definitions and project plan ning, many contracts make the first milestone the setting of the milestones for the entire project.

Example: "Level two characters in" means to you that the art assets will be complete and rendered, but not fully functioning, while the publisher is expecting to see the characters fully integrated and finished.

It is also useful to include definitions of core terms like Bug, Alpha, Beta, and Gold.

• A bug is one of the following:

1. A repeatable phenomenon of unintended events or any action occurring during the running of the game rendering it partially or completely nonfunctional

2. A failure of the game to conform to the design and technical specifications

3. A detriment to the audiovisual elements or function of the game

4. The destruction, disruption, or corruption of a data system, storage device, or mechanism

• Alpha is a version for which the content and code are complete according to the design and technical specifications submitted, including all features, front-end, intro/endgame sequences, screens, sound/music, with some bugs .

• Beta includes all of the alpha definition plus translations from the localization kit, containing some bugs but no known active level "A" bugs (those that will cause the game to crash or freeze).

• Gold is the final version of the product delivered on a CD-ROM (specify the number of copies to be delivered) with the complete asset pack including all source code (organized in labeled files), art/cinematic/music files, and all necessary written documentation required so that a programmer of reasonable skill can modify the game if necessary at a later date.

Publisher Acceptance

Once you meet a milestone, the publisher needs a certain amount of time to review it (ten days is sufficient) and either accept or reject it. Set out sufficient grounds for rejection, such as significant deviation from the milestone definition. It is important to establish what creative approval and input the publisher will have: if creative issues are a ground for rejection, set out a baseline so that you don't get a new producer mid-game who "just doesn't like" the previously established creative direction. Any rejection must be accompanied by a detailed set of fixes required for acceptance and a reasonable amount of time for you to make such fixes (30 days). It is reasonable for you to be entitled to two efforts to cure before the publisher can entertain termination.

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For administrative facility, you will want the publisher to specify in the contract one employee (subject to change with written notice from the publisher) with the authority to approve all milestones, and have the publisher send that name to you in writing.

By laying out timelines and grounds for rejection, you can prevent two unpleasant situations:

1. Submitting a milestone on time and not getting paid for three months because the publisher has no acceptance deadline.

2. Having a publisher use arbitrary milestone rejection as a way to terminate a project for convenience while receiving the benefits of termination for cause (see the "Termination and Rights After Termination" section later in this chapter).

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It is not uncommon to submit a milestone, have it accepted, and still have to wait for the milestone check.This is a vagary of the industry, and a developer's best defense is solid contract language and careful financial planning.

Modifications

The publisher will want the right to request modifications to the game mid-project. Although a certain amount of give-and-take (also known as "reasonable requests for modification") is to be expected, you will want to avert feature creep (where small features get added slowly and end up sinking the project) by stating that any significant modification requests not due to developer error will be accompanied by proportional deadline extensions and advance increases .

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CAUTION

It's not always the publisher who is responsible for feature creep; teams can get very excited about a great feature and insist they'll do the over time to implement it.The development executives can fall into the logic that it's okay to spend more of their own money on the game because they'll make it up in royalties. Be aware that this can lead to two unpleasant realities: first, your developers will likely be putting in over time just to make the original design spec, and may be burned out by any expansions; and two, any cash cushion that you have put away will get eaten up by an expanding game, which may not generate enough royalties to cover the money you spent on those extra features.

Delay

What if you are late? It has been known to happen, althoughas mentioned earlier in this chaptera developer stands a much better chance of success if it earns a reputation for accurate scheduling. There are a few contractual approaches to the problem, generally a combination of leeway, fines, and termination: one good compromise is to give you a "bank" of late days (10 to 25) to be distributed as you need over the course of the development, with further lateness resulting in fines and/or the publisher's ability to terminate the contract for breach (see the following "Termination" section).

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No matter whose fault the delay is, all parties may suffer from lost opportunities due to missed retail windows.Wherever possible, work with the publisher to compensate for unexpected delays.

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It is important to distinguish between lateness caused by you and lateness caused by third-party situations, such as the publish er's request for a modification, delay in providing development kits, or problems with third-party vendors chosen by the publish er, such as engine licensors. Only those delays due to developer error should by counted toward the bank of late days.