One of the questions that always comes up when I’m forming a new game company for clients is “How do we divide the equity?” There are a few ways to go about it, each with their own pros and cons. Let’s take a look at the options.
An even split – an equitable solution?
One way that many new companies divide their interests is the simplest way: evenly. If you and your partner(s) do an even split, that definitely SEEMS fair. An even split, particularly between two company members, can introduce some issues, though.
With two equal “votes” on every issue, what happens if you can’t agree? A deadlock during development of your first game can be crippling to a new company.
Another major issue with an even equity split is when one member does a lot more work than the others. There’s almost no way to foresee how much each LLC member will do for the company when you’re first setting it up. If you’re spending every waking hour on the company, while your partner is just working a few hours on the weekends, that seems very unfair.
Unless that other member has invested a lot of money or some other property, an even split can easily end up tearing the company apart due to hurt feelings, jealousy, or a sense of unfairness. We’ll get into how to deal with this later.
Uneven splits – more fair to those who work harder?
Other new companies split up their equity unevenly in order to better reflect anticipated contributions. This can seem a bit fairer, since the ownership is theoretically more accurate when compared to an even split. This can also vest a majority of control in one of the members, rather than opening yourselves up to the deadlocks that come from an even split.
However, the same issues crop up. What if your anticipated division of labor and control doesn’t pan out? You could still be left with someone doing little work, but getting the lion’s share of both ownership and control of the company. Is that fair?
Some other possible solutions
In my law practice, I’ve seen the issues of control and deadlocks dealt with in a few different ways.
In the event of a deadlock on a decision, your operating agreement could require that an independent party is brought in to arbitrate the dispute (sometimes as many as 3 independent parties!). This can get expensive, as the arbitrators are expecting to be paid for their time.
Another way to deal with it is to give an appointed manager control over the day-to-day management of the LLC. Only certain major decisions, like whether to sell the company or take on investment or debt, require the unanimous vote of all owners. This seems to be the best way, as the manager can be one of the members, but retain 90% of the control over its operations.
Lastly, you could write certain time commitments into the operating agreement or an LLC resolution. The LLC interests could be subject to repurchase, should the member’s time spent on the LLC not reach a certain level (and is not cured within a reasonable amount of time).
These are just a few ideas for solving this difficult issue. Another way to do it, though, is to build the realities of startup commitments into your LLC itself. You do this using a Dynamic Equity split.
What is a Dynamic Equity Split?
I came across a really neat solution to these equity problems a year or so ago when I found the book Slicing Pie, by Mike Moyer. The system that Moyer lays out in the book (and its companion on implementation, Fair and Square) is one that allows for the ultimate equity split to shift dynamically up until a certain event.
How does it work? Basically, everyone keeps track of what they put into and get out of the company. Time spent working for the company is tracked in units. Money invested in the company is also tracked. So is any salary that you get paid, which essentially subtracts units.
This is good. This is fair.Certain contributions are more highly valued, such as cash investment. Every dollar of cash is valued at twice as much as someone’s time, because having cash on hand is so crucial in these early stages. People need to eat and bills need to be paid, after all.
At some point in time, the company will be able to pay its own bills from the profit that it’s generating. Or, an investor will come in and invest a large amount of money to keep the company going. Sometimes, the company will just be bought out entirely.
It’s at this point that the equity share freezes. If one team member has been pumping a lot of cash into the company, they’re going to see their slice of the pie realized at a fairly high percentage. Similarly with the balance of hours put in by the various members. This is good. This is fair. I believe that this type of setup is one of the best ways to form a company that has an uncertain future.
Resources for Game Developers
Here’s the books I discussed in this post. Full disclosure: these are all Amazon affiliate links, which help support the blog and podcast!
Mike Moyer’s “Slicing Pie” – understand how the Slicing Pie system works
Mike Moyer’s “Fair and Square” – learn about how to implement the Slicing Pie system
I should also caution that all of these moves should be done with the assistance of both an attorney and a tax advisor. While we’re at it, here’s a couple great books about the tax aspects of game development:
For assistance with setting up your game studio, from LLC formation to getting the proper contracts in place, contact a game lawyer. Also, check out my ebooks and other goodies by signing up for the mailing list over on the right.