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This article is written by Varun Vishnuvardhasa, pursuing Diploma in M&A, Institutional Finance and Investment Laws (PE and VC transactions) from LawSikho. The article has been edited by Zigishu Singh (Associate, LawSikho) and Ruchika Mohapatra (Associate, LawSikho).

Introduction

The development of video games started way back in the 1980s in the USA with the creation of arcade games, since then there has been a rise in the gaming sector. Over the years the gaming industry expanded enough to take over the entertainment industry. As of now, the gaming sector is worth about $145 billion US dollars globally and it’s still on the rise. The gaming industry was founded in 1972 by Nolan Bushnell, the founder of the gaming company known as  Atari. It also became a milestone and set a benchmark for the development of a large scale gaming community. 

As a result of this the production, distribution, and development of computer games have become highly complex and this sector has attracted more investors globally and has become a multi-million dollar business.  It is no surprise that there are loads of Mergers and Acquisitions in the gaming industry that have increased significantly in recent times. With a lot of acquisitions, comes a lot of investment like an investment of 1.2Billion US dollars in Epic games via funding rounds and the acquisition of Koch Media group by THQ. The gaming industry has also witnessed a change in the shift of platforms with the evolution of television and digital gaming models. Nowadays every sector has its legal challenges or any other constraints. So the parties entering this industry or acquiring any gaming company should understand the various legal constraints or industry-specific rules for a better and successful deal. 

Legal issues

Some of the gaming giants like Niantic, a collaboration with Nintendo and the pokemon company, the global video gaming sectors continue to grow at a rapid pace reaching $56.3 billion globally in 2020. Global video game giants like Fortnite (Epic games ltd) and Mine Craft (Xbox Game studios) have also continued to be competitive in the global market with a turnover of around $375 billion.

The acquirer should keep in mind the various legal issues while acquiring a gaming company. Nowadays with a lot of acquisitions taking place, the number of legal complaints have also increased. Broadly the following points require consideration while acquiring a gaming company:

  1. Intellectual property,
  2. Data Protection,
  3. Employment issues,
  4. Contractual issues,
  5. Shareholding issues, 
  6. Regulatory compliances,
  7. Tax implications,
  8. Due diligence,

Other issues:

  1. Market saturation 
  2. End-user experience
  3. Loot Boxes 

Intellectual property 

Before the acquisition of a company apart from due diligence one has to take note of Intellectual Property (IP) infringements. In the present scenario gamers and the creators are known as the hearts of game studios. Nowadays everything created in a game can come under the protection of intellectual property which includes art, design, technology, source code, patents, copyrights etc. for any investor or a buyer of a gaming company the intellectual property and its creations must belong to the game studio. Often the agreements between gaming companies state or reveal that the IP related documents are poorly drafted which can lead to problems in the form of lawsuits in the future. So it becomes important to look into IP issues before and after the acquisition of a gaming company. The buyer/acquirer, just like a due diligence procedure,  needs to conduct IP searches to verify all the IP related to the selling company. 

Example: In the USA there’s a US Trademark and patent office for IP related queries etc. Another issue for IP related issues for the acquisition of target companies is to look upon Open source software (OSS) which is commonly used in software development. 

Data protection 

With the onset of the advancement of technology, data thefts have increased. Tim Barnes Lee a famous data analyst says “Data is a precious thing and will last longer than the system itself”. In 2014 sony was hacked by cyber hackers and millions of users personal information was leaked. This is one of the biggest data breaches in the company. These are protected by a specific law [Data Protection Act]. The recent data breach was in June 2021 in Linkedin where 1.1 billion users’ information was posted on the dark web. Many countries have come up with data protection laws that need to be complied with by companies handling the data of their citizens. Some games have components like multiplayer, downloadable content, registration, etc. which requires the personal data of the users. The developing companies of these games will be required to follow the compliances laid down by the data protection legislations of the country in which they choose to do business. Hence, the developing data protection jurisprudence adds another issue that needs to be considered by companies looking to do business in the gaming industry.

Employment issues 

This may not be a specific issue in the acquisition of a gaming company but it still plays an important role as the employees of a gaming company especially the coders, engineers, graphic designers are the key personnel of a gaming company. . so it is crucial for the acquirer and the target company to look into the employment practices with respect to compliance of the employment laws, special care must be taken for the employees for trouble-free employment. Some of the companies also give stock options for the employees commonly known as ESOP ( Employee stock ownership plan) as a part of the compensation plan. However the acquirer company shall also look or adhere to the employment laws failing which may impose statutory fines which would be fatal for any M&A transaction if not appropriately addressed, the acquirer may also want to look upon the issue of equity options to its employees as stated above in order retain the employees favourably. 

Contractual issues 

Publishers, game engine developers and middleware distributors often deal in contracts or agreements which need to be reviewed during the due diligence process of M&A transactions. The acquiring company needs to review all the contractual agreements with third parties or the target company to ensure everything is in order and there are no violations, pending lawsuits, etc. Any violation could potentially delay the transactions. 

Shareholding issues 

This may not be the main issue but the companies need to look into the shareholdings of the company this may also be termed as corporate concerns. If the buyer is only interested in only participation rights in the gaming company the buyer is proposed some various issues relating to shares which have to be considered before selling the shares or buying shares the shareholders of the target company should look into preemptive rights, tag/drag-along rights and ROFR etc . the rights and obligations of the shareholders need to be agreed and regulated with other shareholders 

Regulatory compliances 

Every acquirer also needs to look at all the relevant laws before acquisition. The acquiring company needs to stick to the rules and regulations that are relevant to particular deals to avoid any violation during transactions. Data collection and storage plays a vital role in the gaming sector however these are subject to the laws of that country and it differs from state to state and nation to nation, the parties should also look into the data privacy laws to avoid any post-closing liability violations. The acquirer before entering into the transaction should closely monitor the regulations as they may change over a period of time.

Tax implications 

Just like any other transaction every company needs to comply with the taxation laws which are pertinent to a deal  tendered tax implications, some of which are:

Capital gains tax

The laws on capital gains tax differ from country to country. The acquirer company should explore or investigate various rules which might be helpful in the future to avoid any violations. The gains arising out of the transfer of capital are taxed however it differs from country to country. If M&A transactions involve companies operating in two different countries then compliance with the tax laws of both countries needs to be adhered to

Tax on transfer of shares

This transfer of shares may attract stamp duties and securities transactions tax. If the transfer of shares is dissolved then no tax may be placed upon the company 

Tax on business assets

This is levied upon the assets of the company however these regulations change from nation to nation.

Due diligence 

This due diligence is considered paramount in any transaction, in a layman’s sense it is considered as a checklist before the acquisition of a company. The acquirer conducts this before acquisition as they check upon the liabilities, financial records etc of the target company. It’s like an audit or a preliminary investigation. A due diligence checklist contains:

  • Annual report,
  • IPO,
  • General risk management,
  • Intellectual property issues (if any),
  • Antitrust regulatory issues,
  • IT concerns etc.

An important thing about due diligence is that the acquirer or the buyer can get to know about the various leads and issues of the company. It also helps in knowing the cost of integration and potential revenue.

Conclusion

Acquisition of gaming companies is similar to that of acquisition of any other company in the market keeping in mind some specific requirements of this industry that were discussed. With the onset of Technology, we can see a boom in the gaming industry. Analysts predict that the gaming industry would create revenue of around  $260 billion in the future. As more and more independent developers and small and medium-sized gaming companies enter the market the scope of mergers and acquisitions in this industry will increase as well resulting in the need for more regulations in the industry. With the evolution of data protection laws around the world and a stricter intellectual property protection regime, the quantity and quality of compliances will increase as well. 

References


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