Financing game businesses

The global video game industry has seen massive growth in recent years, with total revenues exceeding USD180bn in 2023. During this time, investment has greatly expanded, encompassing both traditional and newer sources of financing.

Between 2020-2023, it's estimated aggregate venture capital and corporate investment into gaming businesses exceeded USD31bn. In the same period, it's estimated the value of M&A activity exceeded USD170bn. This growth has greatly expanded the available sources of game finance as the number of investors – both venture capital and corporate – has grown significantly.

However, this growth has also come at a time when the cost of game development is growing exponentially. The drivers for this are multifaceted but include a challenging macroeconomic landscape as inflation has pushed up costs, and a hyper-competitive AAA market demanding ever-larger, more complex and graphically intense experiences. Between 2018 and 2023, to take one example, the development budgets on Insomniac's Spider-Man franchise grew from around USD100 million for the first game and around USD156m for the second to around USD315m for the third.

As the game financing market has slowed due to the tougher economic climate, the challenge for founders, studios and investors has grown. Pairing the right development project with the right source of financing is key. There are two main funding models in the industry: publishing and equity investment, with a number of alternative options also available.

The traditional model: working with a publisher

For a long time, partnering with a publisher was the most common way to finance a game. The developer-publisher duo is one of the core relationships of the industry. While a developer is typically the creative who designs and builds the game, a publisher specialises in the broader process of marketing and bringing the game to market.

The key benefits of working with a publisher include development funding (usually tied to milestones), marketing, distribution (both physical and digital), and general advice based on years of industry experience. Publishers also tend to support a range of developers from established independent studios to smaller start-ups.

Publishers will require exclusive rights to distribution and a share of game revenues. Publisher funding is often based on a milestone system (ie funds are given when certain development milestones are met) and this can create issues for developers. These include restrictions on creativity and the exploration of different ideas (as specific milestones and design specifications need to be hit) and the withdrawal of funding if milestones are not met, leaving a developer unable to pay for all expenditure, particularly payroll.

At the heart of the developer-publisher relationship is the publishing agreement. Many customary terms have grown up around these, and publishers will often have their own 'house-styles'. These agreements vary from relatively simple to quite complex. They will typically cover more than just development and distribution of the game, encompassing issues like IP ownership, rights to sequels and merchandising, royalties and revenue share, and termination rights.

It's crucial to clearly identify which game(s) are subject to the agreement and the key milestones and development timetable expected. These should be specified in as much detail as possible to avoid future disputes.

Recent years have also seen growth in work-for-hire studios as the costs and resources needed to produce AAA games have grown. Many studios use work-for-hire as a source of steadier, lower-risk revenue which allows them to build their studio and also work on their own projects and IP. There are notable examples of studios finding great success with this approach, growing into large independent developers in their own right (such as Behaviour Interactive).

The financing model: taking equity investment

The other main source of funding for a game project or studio is selling equity in the business in exchange for capital investment. This is often a significant step in the growth journey of any business and brings with it great opportunity, as well as challenge.

The number of investors focused on the gaming industry has grown substantially in recent years, including sector-focused venture capital funds (such as BITKRAFT Ventures, Lightspeed Ventures and Griffin Gaming Partners) and strategic corporate investors (such as Tencent Games). Understanding the different types of equity investors and what their drivers are is crucial to determining whether equity investment, and a particular equity investor, are the correct fit for a development project.

The three main types of equity investor are:

angels
venture capital (VC) funds
strategic corporates (strategics).

Angels

Angels are usually high net worth individuals who may have been founders before who will typically invest sums into new gaming companies, usually in exchange for common equity and on relatively simple terms. They usually invest lower amounts than VCs or strategics but will often have good knowledge of the industry and experience as a start-up founder. Angel investor capital also tends to be more patient than VC capital.

Angels are looking to invest early in businesses which have the potential to attract further investment from VCs and grow in future. In the UK, such investors will often benefit from certain tax incentives – such as Seed Enterprise Investment Scheme (SEIS) and Enterprise Investment Scheme (EIS) relief – which have significantly expanded the angel investor base in recent years.

Venture capital (VC) funds

VC funds pool money on behalf of financial investors (such as pension funds) to invest in high-growth businesses and make significant returns. They're high-risk investors. The classic model of VC investing will see the bulk of their investments making little or no return, but a small number will make such large returns they carry the whole fund.

A typical VC fund will operate on a ten-year cycle – meaning that within this window the fund must be raised, deploy its capital into a business, see that business achieve significant growth, and ultimately have its investment released (usually through an M&A exit or IPO) and return the profits to investors. In this context, VC is generally not patient capital and will seek investments which have fast growth and high exit value potential.

This will drive the types of game studio and projects which are suitable for VC investment. For example, a mobile game start-up by a founder team with prior experience at a major mobile publisher and a strong understanding of mobile unit economics and platform trends is a classic VC investment opportunity. By comparison, a small PC/console studio making an indie title with a more niche target audience may be better suited to working with a publisher.

Strategic corporates

Strategics corporates (or strategics) sit somewhere between VCs and publishers. They will typically have their own business in the gaming industry (eg a publisher) but will also make minority investments in businesses which they see as having strategic value to their core business. In many instances, this is an initial step towards an eventual acquisition if the business is successful. In others, the investor may be happy to remain a minority shareholder and seek to expand the commercial relationship. Strategic capital will invariably be more patient than VC and is not necessarily looking for a quick exit after rapid growth.

The terms of equity investment will often be complex and will require professional legal advice. In high-level terms, the investor will typically provide capital in exchange for shares in the business, usually in the form of preferred shares which rank ahead of the founder equity if the business experiences difficulty. These shares also carry special rights. In early-stage investments, the percentage share in the business demanded by investors will usually range from 10-20%.

Day-to-day management of the business and creative autonomy will generally sit with the founder team, although investors will demand negative controls over material issues (eg agreeing the overall business plan or issuing new equity). The investor will usually take a director seat on the board and there will also be detailed terms around information reporting and dealings in the company's share capital (including investor rights on anti-dilution, pre-emption, right of first refusal (ROFR), and drag-along). As investors are investing in the founder team as much as the IP and technology of the business, founder share capital will also often be subject to detailed vesting arrangements which could see the founders lose some or all of their equity if they leave the business early.

Raising equity finance is a complex process and won't be right for every game business. It does however have the potential to unlock significant capital and rapid growth. Many developers have leveraged equity finance to unlock rapid growth which has allowed them to scale into successful gaming and technology companies (including the likes of Epic Games, Peak Games and Dream Games).

Alternative options

Beyond publishing deals and raising equity financing, other sources of funding for game projects are available and can often be used in combination with those key sources of finance.

Crowdfunding

Crowdfunding has become a viable source of financing for developers. Some projects have raised millions of dollars through online crowdfunding platforms, eg Larian Studios’ Kickstarter for Baldur's Gate 3.

Typically, investors obtain rewards (such as early access, additional content or in-game recognition) in return for their investment. Crowdfunding is appealing for developers as they don't usually have to dilute their shareholding, cede control of creative development or share revenue with investors. For these reasons it's becoming increasingly common even for more established developers to use crowdfunding in conjunction with another source of finance.

The main risk with crowdfunding is that a developer will need to set a funding target on the online platform used and if this isn't met, no funding is made available. On average only half of crowdfunding projects meet their target. The sums available via crowdfunding are also often smaller than those from a publisher or equity investor.

Government grants and tax credits

Financial support is often available from the public sector in the form of government grants and/or tax credits. There are many well-known schemes in various territories, including the UK and the European Union. In the UK, these include the UK Games Fund, Video Games Tax Relief (VGTR) and Video Games Expenditure Credit (VGEC). Industry trade associations, such as Ukie in the UK, also provide detailed information on these sources of finance.

Specialist debt financing

While traditional bank lending has historically been effectively closed to gaming businesses – since they lack the predictable revenues and tangible asset base for use as security which banks often require – specialist finance providers are increasingly looking to service the industry. Providers will often aim to offer debt finance, which is non-dilutive unlike equity financing, meaning the founder team doesn't give up ownership. Funding is usually secured against near-term receivables and/or government grants or tax reliefs which haven't yet been paid. In this context, such finance can be useful for cash flow management but will rarely be a core source of development funds.