This article is written by Riya Dubey who is pursuing a Diploma in M&A, Institutional Finance and Investment Laws (PE and VC transactions) from Lawsikho.
Table of Contents
Introduction
The e-sports industry is not new but now presently it’s working at a fast pace and of course, due to the pandemic attention has been diverted towards e-sports in 2020 this is evident from increasing investment in the e-sports industry. Now the industry has developed in all its aspects from sound, music, graphics design to storyline.
This development in the e-sports industry has led it towards getting acquired by the big company. In the past few years trend to acquiring these e-sports companies have increased and it is not going to slow down in the coming years. Thus, an increase in M&A transactions can be noticed in the e-sports sector. So, here we are going to emphasize the legal aspects of the M&A transaction.
E-sports a booming industry
The report shows that by 2022 eSports can have more people interested in it than traditional sports. Even e-sports are now using franchise models such as NFL and NBD, the price tags of these are growing continuously. Certain franchises are valued between $50 million and $80 million. According to the data published by SafeBettingSites, investment in e-sports by the third quarter of 2020 rose by 714% to reach $1.33 billion and the M&A and investment transaction has crossed $17.5 billion. The M&A value in the same quarter was $11.65 billion which saw an increase of 262% QoQ.
According to Insider Intelligence estimates that viewership of e-sports between 2019 and 2023 is going to increase by a 9% compound annual growth rate i.e. from 454 million in 2019 to 646 million in 2023.
What acquirer looks for while acquiring any e-sports company?
Recently, in April 2021 GamingMonk has been acquired by the Mobile Premier League. Here, MPL has acquired the complete team of GamingMonk. When it was acquired it was having a registered user base of approximately 1.3 million. This deal is going to allow MPL to explore and develop all aspects of e-sports. This happened because the GamingMonk team was having a very strong record in the past in both offline and online e-sports tournaments.
In January 2021 Helix e-sports and ggCircut got acquired by the Esports entertainment group. Esports entertainment groups have paid $43 million for these to business. This is going to strengthen the “pay, watch, and bet” strategy and the diversification of the Esports Entertainment group. The business which got acquired were having a strong user base and around 1,000 connected locations.
So from the above deals, we can conclude to some extent that acquirer while acquiring any e-sports company looks at the following things discussed below.
How M&A in the e-sports industry go hand in hand?
The growth and development in eSports have led to issues related to M&A. There are spots in the e-sports league that can be offered for sale for profit by the team to fill the spots. The sale of these is treated as similar to any other tangible property. Thus, it makes sale negotiations and contracts important for all the M&A transactions in the e-sports industry. The boom in the e-sports industry has created a scope of M&A transactions in acquiring the e-sports companies and it has now become a hot market.
One has to make sure what are pros and cons before acquiring any e-sports company and for this due diligence is conducted. The success of the acquisition to the great aspect is dependent on how properly due diligence is conducted.
In the e-sports sector due diligence is generally conducted in the following areas:
- Business and financial due diligence;
- Accounting due diligence;
- Legal due diligence;
- Information Technology due diligence;
Here we will be discussing how legal due diligence is conducted in e-sports industries.
Legal Due diligence
Due diligence plays a significant role to shorten the time period in executing a deal. One should start due diligence at a very early stage to make the acquisition a successful one. It is best if both parties conduct due diligence from their side. And sellers should always discuss with their advisory team before setting up the data room. If there is any known flag it should be shared with the seller’s advisory team as early as possible to get the issue resolved.
We can say that by conducting due diligence investors get confirmation that all information provided by the seller is accurate. It includes a deep review of finance, market accessibility, and competition, and other areas of the seller’s company.
And when it comes to the e-sports industry there are lots of industry-specific aspects which are of concern for investors while conducting legal due diligence on the seller.
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Shareholding Issues
While acquiring any e-sports company acquirer has to be very careful as all these companies start as a small independent start-up and have to go through series of fundraising rounds and thus there are chances that that VCs or institutional investors have rights in the company’s shareholding structure. Few of these rights which are available to security holders to have security in the business are veto rights, pre-emption rights, right of first refusal, tag-along right and redemption rights, etc.
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Issues related to Intellectual Property
It includes almost everything that has been created while making the game like the art design, the music used, the storytelling line, the technology, the source code, and many other things. Therefore, the game studio is most important for the acquirer or investor.
Rarely, while reviewing the employment agreement and independent consultants agreement of gaming companies (if any) shows that the IP rights for transferring and ownerships have been drafted poorly. If it has been drafted poorly then it creates ambiguity for deciding who owns the ownership and transferring rights of IP, employees, or gaming consultants or the gaming company.
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Issues related to IT
The game is created by the studious works on certain platforms like Xbox, switch, and PlayStation, etc. The companies which develop platforms like these enter into the service and license agreements with gaming studios which permits the gaming studious to use that platform for creating games.
Here, the chance of control clause has to be reviewed carefully as it gives termination right without giving any notice for the respective agreement if there is a change in the majority shareholder in the gaming company or if no information is provided to the licensor in this regards.
And attention should also be given to the board compliance clause because many times IT firms overburden the gaming companies with the obligation to comply with each and every existing law. This makes the company concern about losing the prime software license if any breach of law arises.
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Employment Issues
The gaming companies to provide support to their employees hires external service providers like developers and consultants for getting their special and creative knowledge to meet the current demand of the market even without employing them permanently.
This creates trouble if their employment agreement is not drafted properly because if they will be characterized as an employee then it creates a responsibility on the company to pay social security contribution.
Things that indicate that the external service provider is similar to an employee are:
- The external service provider uses gaming companies email and telephone number;
- Working hours of the external service provider;
- The extra work that is allotted to the external service provider.
Post contractual clauses like non-compete, non-solidarity clause, or confidentiality clause should be reviewed carefully because this can result in future consequences and they are the big red flag to the deal.
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Negotiation in Acquisition Agreements
The negotiation part is very important because through this the acquirer can transfer the several risks relating to the gaming company to the seller by including:
- seller’s representation and warranties clause:
The acquirer here tries to protect their interest from the aforementioned. It covers representations and warranties for IP, employment, and IT, etc.
- Representations and warranties for IP: It includes validity and enforceability to the IP produced by the e-sports company. It should also be checked whether any litigation is going on with regards to the IP rights of the e-sports company.
- Representations and warranties for IT: The seller has to give validity that the e-sports company’s IT are all licensed and will not expire in a short time period after the acquisition of the company. The acquirer can ask the seller for providing warranties that data is fully secured, regular back of data is done, and no data loss has taken place in the past.
- The seller would have to confirm that the change of control rights will not terminate the existing contracts. If while doing due diligence it is found that the change of control right will impact the existing material contracts then the acquirer should make sure that such right gets terminated before completion of the transaction and should be kept as a condition precedent under Condition Precedent Clause.
- The acquirer can ask the seller for a warranty if open source software were used for the development of the game by the e-sports company that no rights have been granted to the third party to disclose the source code.
- Representations and warranties in employment: This part is very crucial in the representation and warranties clause. The seller has to guarantee compliance with all labour laws that apply to the company like the Payment of wages Act, 1936; Maternity benefit Act, 1961, etc.
- Seller’s indemnification clause:
Under the indemnity clause, the acquirer can ask the seller to indemnify the acquirer against any or all the liabilities whether it is for present, future, or past.
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Payment terms:
The earn-out agreement has to reviewed while conducting due diligence in e-sports as we frequently have earn-out payment in the share purchase agreement. Earn-out in simple terms is a future compensation that the seller gets in the future if the business achieves certain goals decided between buyer and seller.
When any e-sports company is getting acquired, there are high chances that one or the other pipeline must be going on with that company and it becomes very difficult to predict the future economic success when the company is getting acquired. Therefore maximum time we get to see earn-out payment agreement as it helps the parties to deal with the disagreement they were facing.
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Corporate concerns:
When the acquirer acquires the e-sports start-up then he needs to decide whether he wants to acquire all shares/majority shares/minority shares of the company.
- If the acquirer wants to acquire all the shares then he has to persuade all the shareholders to sell their shares.
- When the acquirer wants to acquire majority/minority shares then he needs to deal with certain shareholder’s rights given to shareholders under shareholders agreement or Article of Association of the e-sports company like pre-emptive rights, tag-along right, right of first refusal, etc.
Conclusion
There is no need to tell how 2020 started and the impact of covid-19 worldwide but this increased the interest of people toward e-sports and now we can see that covid-19 does not have much impact on the investments in the e-sports sector. This has led to an even increase in M&A transactions in the e-sports industry.
To conduct due diligence under M&A before acquiring any e-sports company is very important. It helps to make a sensible decision as it let to know what are risks and liabilities one is going to acquire with the company. To be sure that your interest is protected adequately I would suggest you hire a professional team who has experience in conducting a transaction in this area.
Reference
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