31 July 2020
Download - August 2020 – 2 of 6 Insights
The video games market has seen a number of high profile exits in the last few years at valuations that have caught the attention of founders, investors and competitors alike. This has created an exciting and lively space for M&A activity, which is likely to be undented by the COVID-19 crisis. While no two M&A transactions are ever the same, there are several considerations to bear in mind when approaching an exit – whether as a buyer or seller.
The likely deal timetable depends on the process the sellers and their financial advisors wish to run. It's not unusual to run a formal competitive process when selling a games company. This entails negotiating with multiple potential buyers for as long (or as short) as desired in the particular set of circumstances, resulting in a likely longer deal timetable, but also potentially the best outcome for the sellers.
The sellers control the timetable until they select a preferred buyer; this might involve entering into an exclusivity period with the selected buyer, but it's equally possible to run an auction process without exclusivity, almost right until the point of signing. The approach depends on how the relevant bids measure up against one another, and the nature of the buyer's agility and view of the business.
The alternative is a bilateral process, where a single buyer and the sellers come to agreement on the terms of the acquisition early in the process. Predictably, this is a simpler and faster route which does not necessarily result in a lower valuation of the business, but it will be down to the financial advisors to advise as to whether this is the more suitable approach.
It's important to start thinking about due diligence as early as possible. An efficient and controlled diligence exercise can significantly shorten the deal timetable, and the starting point is a well-organised and thought through data room which will be expanded as needed, following questions from the buyer's advisors.
The sellers should always discuss due diligence with their advisors before the data room is set up, to help with its structure. Any known issues in the business should be flagged to the sellers' advisors as soon as possible in order to agree on approach and to be proactive in providing the buyer with relevant information early on.
A key aspect of M&A transactions in the games market is the composition of the company's cap table. While a large part of the company is usually still held by the founders, it's now common to see a games business go through fundraising rounds and therefore end up with one or more venture capital funds, or other institutional investors in its shareholding structure. The investors will focus on the terms of the transaction documentation, as well as the funds flow. The approach to the funds flow can be best summarised as maximising the cash the investors will receive on day one and making sure that it mirrors the waterfall in the latest investment documents. It's therefore best to share the first draft with the investors when ready, to give them time to digest internally and raise questions.
Regarding the transaction documents, the investors will be keen to ensure, among other things, that any residual liability in respect of the warranties (eg the ability of the buyer to attempt to claw back a part of the price paid for the business) is very limited and that they are only giving title and capacity warranties on a several basis – and consequentially not giving any business warranties.
Another crucial workstream on a sale of a games business is managing the communication with the company's employees. While it's vital early on to keep the matter confidential and limit the number of employees involved in negotiations to senior management, employees will need to be made aware at some point, and the timeline of when that happens is something to be agreed between the buyer and the sellers.
In most cases, employees would have been granted options in the company to incentivise them to stay with the business and reward performance. Such options might include vesting and acceleration provisions, and the usual process is for all options to be exercised immediately before completion. Therefore, the buyer and sellers' advisors should be involved promptly in order to review the options documentation in place and prepare paperwork which may need to be sent to (and signed by) many individuals. Advice is needed to make sure any option grants have been carried out properly and that the company is in full compliance to ensure both talent and company achieve the planned tax treatment. There can be many challenges to optimising share option schemes at the point of exit depending on the jurisdiction of the target.
The buyer will also want to think about incentive structures going forward as employees, particularly key developers, are a crucial part of the value of the business. The buyer will typically involve the founders in future planning; after all, they know the business and employees best.
As with key employees, the buyer will, in most cases, be looking to tie the founders into the business at least for the initial couple of years, helping with continuity and providing historic, in-depth knowledge of all key components of the business. Incentivising founders to stay could involve an earn-out where the founders need to ensure the company performs according to certain pre-agreed metrics to receive any further sale proceeds. Another possibility could be to provide the founders with equity in the buyer or target post-completion, depending on the nature of the buyer and the structure of the deal. Incentive models can be entirely bespoke. Concepts of 'good leaver' and 'bad leaver' are very relevant to these types of arrangements.
While the above checklist of considerations provides a useful cheat sheet for all M&A transactions in the games space, nothing replaces the benefits of seeking specialist advice at the outset to ensure the best possible outcome for the buyer, the sellers and crucially the timetable. Being proactive means that, as the deal progresses, the parties can focus on the more exciting tasks such as post-completion planning while their advisors bottom out the rest. We are here to help get you to this point as quickly as possible.
by Jo Joyce