Overview
Franỗois Dominic Laramộe
<francoislaramee@videotron.ca>
Preparing a business plan might well be the single most important action taken during a game development company's startup phase. Not only will the business plan help secure financing, but the research process leading to it will strengthen the promoters' knowledge of the market, solidify their business strategy, and establish their credibility with clients and partners.
Multiple business plan formats, sharing much in content and structure, have been published over the years.
[Gumpert96], [Touchie98], and especially [Bangs98] present several alternatives. The model described in this article is a hybrid modulated to the needs of game developers. The author has used variations of this model to write business plans for several successful clients since 1998.
The Many Purposes of the Business Plan
Your studio's business plan will come into play during all phases of the company's operation, in a variety of roles:
Strengthening your own convictions. The research leading to a business plan will help you determine whether the opportunity you identified really exists. If you want to start a motion-capture studio, and 8 out of 10 local studios you poll say they would use the service, you're on your way to success.
Identifying business opportunities. Sometimes, the research process itself will reveal ancillary sources of business you might not have thought about. For example, while asking local publishers about their interest in full-service game development, they might tell you that their existing stable of developers is in dire need of extra 3D animation help; adding a 3D team for hire to your studio's assets could therefore increase profits.
Guiding your strategy. Once you have identified key opportunities, the business plan will help you pursue them effectively—and avoid distractions.
Establishing partnerships. A credible business plan will help you recruit key employees, secure publishing contracts, obtain a favorable lease, negotiate credit, and so forth.
Securing debt and equity financing. Since the safety of (and return on) their money is paramount to them, bankers and investors will base their funding decisions on the viability of the business plan.
Selling the company. Finally, if you ever want to sell your studio, a business plan showing a viable long- term strategy will be your most important asset, especially if the buyer is not intimately involved in the interactive entertainment industry himself.
Therefore, the business plan should be created before the studio's launch and updated on a regular basis (at least twice a year) as long as the company is in operation.
The Business Plan's Contents
A business plan is an organic document. It can and must be tailored to the needs of the person or organization to which it is being presented. For example, if your business is applying for a bank loan, the banker will be far more interested in seeing how you will generate a regular positive cash flow (and therefore be able to repay the loan on time) than in your long-term growth process, while an angel investor will focus on the exact opposite.
That being said, most business plans need to include:
Front materials: A cover page, executive summary, and table of contents.
Market information: A general description of the state of the industry, the niche you want to carve for yourself, and the clients who will buy your products and services.
A description of your company: Your own track record, key members of the team, your staffing plans, and the outside resources to which you have access.
Your development plan: Growth objectives, research and development, other markets you wish to expand into, and risk management.
Your financial plan: How much money you need (and when), your cash flow and earnings previsions, and your capital structure.
Assorted supporting documents: Personal résumés, letters of intent, and so forth.
Length
The complete business plan should not exceed 50 pages (preferably 30), starting with a 2-page executive summary and including 10 to 15 pages of financial statements and supporting documents. This is often insufficient to discuss everything that you feel is relevant; however, not every reader needs to see every piece of information, so you can assemble the 30-page document you submit on a given occasion from substantially more material. Case Study 2.2.1 discusses ways to do this effectively.
Case Study 2.2.1: Modulating the Business Plan
Once you have written all of the material that belongs in your business plan, you can assemble different versions of the document for different purposes. For example:
To secure a work-for-hire contract with a publisher: Emphasize the team and any staffing growth plans (publishers like to establish long-term relationships), leave out the intellectual property except technology, and skim over financial predictions.
To secure a bank loan: Include extensive personal information, make sure that your cash flow forecasts minimize fluctuations, and expand the section on risk management. De-emphasize long-term development.
To define internal strategy: Prepare extensive market research, alternative financial forecasts based on different development scenarios, and leave out team info.
To obtain equity investment: Insist on development plans and on how you will retain your key employees.
In your market analysis, insist on emerging trends with long-term sustainability.
To obtain venture capital: Identify a critical shortage in the market. Show enormous earnings growth potential within two to three years. De-emphasize risk management, except where it concerns very short- term cash flow.
To recruit key employees: Leave out most of the market description (unless hiring outside the industry) and the financial data, and emphasize the company profile and the development plan.
The Market, and How You Fit into It
This section of the business plan might be the most important, because it shows why your business should exist in the first place. Avoid the temptation to skimp on it to save pages for the financial forecasts: in the eyes of the shrewd investor, cash flow statements without a credible market opportunity are worthless.
Your Products and Services
First, describe what your company will do, and how it will distinguish itself from the competition. Examples of unique distinguishing characteristics might include:
Exceptional talent. Do your partners and yourself have marketable industry credentials, advanced degrees, or unusual backgrounds?
Unique intellectual property. Have you developed characters that focus groups have identified as the next Pokémon? Or have you secured an exclusive license to an upcoming film franchise's gaming rights?
Financial advantages. Will you be able to develop better games for less money than the competition?
Why? Is the cost of living very low in your state or country? Is your national government subsidizing high- tech companies?
Geographic specificities. Is your studio located in a high-density game development area, with plenty of competent talent available to be hired? Or are you the only game company in an area teeming with exceptional 3D artists?
Current Market Conditions
Telling the reader that the game industry's total sales have experienced double-digit growth every year since 1980 is not enough: you must also demonstrate knowledge of the specific segment(s) you are attacking. Who are your customers? Are they used to buying what you propose to sell? If so, is there room for additional suppliers? If not, how will you convince them of the benefits of leaving their current partners to do business with you?
The best way to do this is to identify an obvious need in the marketplace. For example, if you want to start a game programming school, ask local companies how long it takes to fill an opening, how many technical positions they have available, and how many more art and production jobs they would be able to create if there were enough qualified programmers to fill the team. (In some countries, the answer to that last question might help you secure funding from government agencies.)
You must also identify trends that support your approach. If you want to develop games for publishers on a work-for-hire basis, show that licensed properties account for an ever-increasing percentage of the best-sellers list on your platform of choice. If you prefer to create your own characters, show that the market for intellectual property of their kind is large, growing, and/or underserved. Be precise, and aim where the competition isn't too strong: while there is a seemingly inexhaustible demand for fantasy, the teenage-wizard-at-boarding-school-in- England sub-genre is probably saturated until at least 2010.
Your Marketing Strategy
Finally, demonstrate how you will carve your own niche in the difficult game development market. Have you secured the services of a reputed agent? Will you begin by developing a low-cost, low-risk title that can be played on personal digital assistants (PDAs), and use it as a calling card? Will you focus on a narrow segment
and establish yourself as an unquestioned leader—like id Software for first-person shooters and Maxis for simulations—or will you develop an entire line of complementary sports games and distribute them on all major consoles?
Your Company
Having identified an opportunity in the marketplace, you must now prove that you and your partners/employees are qualified to turn that opportunity into a profitable business. This section will establish your credibility in this regard.
Promoters
Identify the partners who will be involved in day-to-day operations by name, and describe the skills they bring to the company.
Insist on expertise in three major areas: management, sales, and game development, in that order. [Bangs98]
states that 92% of all business failures in any industry are caused by managerial incompetence or lack of industry knowledge. Bankers and investors are understandably wary of funding companies that they perceive as deficient in these areas. Also remember that most of the people who will read the business plan know nothing about the game industry, except what they might have read in the mainstream press—and that coverage is rarely flattering. Thus, to maximize your odds of securing capital, your core team should include:
A proven business manager, preferably with a finance background.
An experienced salesperson with solid industry contacts.
A game designer or producer with multiple titles to his credit.
A lead programmer, also with multiple industry credits.
Of course, it is possible to rely on the support structure described in the next section to fill a gap in your
expertise, but this is the optimal combination, because investors love it when people who hold long-term stakes in the company occupy the key positions.
Support Structure
Few startups, if any, can count on promoters with all of the skills necessary to succeed. The "Support Structure" section of the business plan lists the employees and external resources that will complement the promoters' knowledge, including:
One or more senior software engineers.
A lead artist, if he is not among the promoters himself.
A law firm and/or agency with entertainment industry experience to represent you in contract negotiations.
Members of the board of directors and/or advisory committee.
Auditors and other consultants.
Local schools and research institutes.
Chambers of commerce and other business associations.
Laws and regulations that favor the game industry in your local jurisdiction.
Staffing
Then, describe your initial team in these terms:
How many people will you hire?
What will their jobs be, and to whom will they report?
What salaries and benefits will you offer? Are you going to pay above or below the industry average in your area? Will you implement a stock ownership plan to minimize employee turnover?
Can the local market provide you with enough qualified talent? If not, what type of training will you have to invest in?
Production Plan
Finally, describe how you will organize the studio's operations. Will you have a single unified team? Multiple projects based on the same engine? Three independent product lines?
Remember that generating positive cash flow early and regularly is important for investors. When seen in that light, a single group working on the same AAA game for three years is not very attractive. You might have an easier time securing capital for a larger company that can release two handheld games every quarter and a major console title every Christmas season.
Development Plan
The development plan describes how you envision your company's evolution over the next few years. In traditional businesses, the development plan usually covers five years; for a game studio, it is very hard to make predictions more than two to three years in the future with any credibility, so a two-year plan will usually be sufficient.
Research and Development
Explain your company's technological strategy. Will you develop in-house engines, license technology developed elsewhere, or take advantage of industry standards such as Macromedia Flash? Do you plan on using technology as your competitive advantage? If so, will that competitive advantage lie in visual quality, character behavior, or faster development? If not, where will you put the emphasis: art, design, or writing?
An aggressive but sound research and development plan is a high-risk, high-reward strategy. While success might bring enormous profits, there is always the chance that you will find yourself, years into a new engine's development, with technology that fails to bring the expected competitive advantage. Therefore, such a strategy will attract venture capitalists, but scare loan officers away.
Growth Targets
Is your goal to keep your company small and easily manageable, or do you want to turn it into an industry powerhouse? Do you want to concentrate on a single platform or develop for all major consoles at the same time? Do you want to become your own publisher? Handle your own distribution? Exclusively online, or in retail stores as well? Or do you intend to take the intellectual property you develop for your games and turn it into a TV, comic book, and merchandising franchise?
Again, an aggressive growth strategy is attractive to equity investors, but perceived as risky by lenders.
Risk Management
The best business plans demonstrate knowledge of the common sources of failures in the industry, and explain how the company will maximize its odds of defeating them. For example:
Many experienced game developers leave the industry because they can make more money and work shorter hours elsewhere. How will you retain your key staff?
A small number of hit games earn enormous profits, while most projects lose money. How will you minimize your financial risk?
The industry suffers from a high employee turnover rate, especially in active areas like California and Texas. How will you keep your teams intact throughout long projects?
As the industry grows ever more concentrated, the number of potential publishers for your games shrinks every year. How will you get your games to market?
The average AAA game budget reaches millions of dollars. How will you minimize your costs and still have a chance to compete for consumers?
Convincing answers to these questions will show that you are ready to face the challenges of the marketplace.
Also note that local circumstances might influence your vulnerability to these risks, or even spawn others. Study your state or country's tax code (especially the provisions on tax incentives for R&D and investment in
technological ventures) and job market thoroughly.
Case Study 2.2.2: Creative Risk Management
Nothing impresses investors quite as much as a proactive, original approach to minimizing the risk of failure.
Here are a few examples of strategies that can increase your odds of success:
Send employees to teach at local colleges and universities, where they can recruit the best students.
Participate in work-study programs.
Implement a profit-sharing plan; this retains key employees more effectively than stock options, because few game companies ever make it to the stock market.
Pool resources and/or trade services with other companies to eliminate the costs associated with the hiring/layoff cycle.
Enforce a strict upper limit to the duration of the work week to maintain morale and avoid employee exhaustion.
Establish strong relationships with the local mainstream and business press to gain notoriety in the financial market and attract quality employees.
Mix and match project types and durations to generate regular cash flow.
Involve employees in every project, if only for a couple of weeks, to create a sense of unity.
Financial Planning
Most companies write business plans to obtain financing. Others do it to secure contracts and partnerships. In both cases, a sound money management plan is of the utmost importance.
Types of Financing Deals
If your studio needs funding, you must determine which type of financial arrangement between you and your backers will be most appropriate. There are three general categories of funding you might solicit:
Debt. This category includes credit margins, "bridge loans" allowing you to cover cash flow shortages until a milestone payment arrives, bonds, and mortgages. Lenders avoid risk, and they want to get their money back (with interest) on a precise schedule. Therefore, debt funding is easier to obtain if you already hold a letter of intent or work-for-hire contract from a publisher, or if you are willing to offer significant collateral (e.g., a house) to secure the loan.
Equity. Family, friends, financial angels, and some investment funds might be interested in providing a studio with long-term capital in exchange for a percentage of ownership—and thus a share of future profits.
Equity investors might be willing to accept a higher risk factor than lenders, but mavericks beware: while any business failure is painful, one that destroys your relationship with loved ones will be much worse. As a rule, investors will expect to earn back their seed money within two to three years and receive a 25 to 40%
return thereafter.
Venture capital. Some investors specialize in high-risk, high-payoff companies. A typical VC contract involves the studio selling a percentage of its stock to the investor at a certain price and buying it back later at a higher price so that the venture capitalist will be out of the picture within 3 to 10 years. Usually, VC is only available to companies with extremely high potential—for example, those that hold the rights to a breakthrough technology or show immediate stock market perspectives. At the height of the dot-com bubble, VC firms expected 100 to 500% rates of return on their investments within one year.
Depending on your company's business model, some of these types of financing will be easier to obtain than others: venture capitalists have little interest in stable, low-growth companies, while banks will not risk large sums unless the loans are secured by contracts with well-defined milestone payments.
Pro Forma Financial Statements
To convince potential investors and partners of your company's potential, you must demonstrate financial viability. To do so, you must provide the following statements:
Cash flow statement. This document lists cash receipts and expenditures, demonstrates your company's liquidity, and shows how much external funding you will need at any given time. Table 2.2.1 shows a simple cash flow statement. Don't forget to take trade show expenses and representation into consideration!
Table 2.2.1: Simple Cash Flow Statement (Simple Studios Inc.)
Equit y funding
$250,000.00
$0.00
$0.00
$0.00
$0.00