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If you are working (or worked) on a game with one or more people, with the intent to earn money from it (at some point), you might already be in a partnership, which can carry some serious financial risk to you if things go really well (or really poorly). Creating partnership agreements (documents outlining the goals, duties, structure, and exit strategies of the venture) can help reduce your risk, or incorporating to a limited liability company (LLC).
DISCLAIMER: THIS ARTICLE IS NOT A SUBSTITUTE FOR LEGAL ADVICE. It’s not all-inclusive, and every person’s situation is different, so you should really consider contacting an attorney if you have questions.
Short on cash? Check out my article on finding affordable legal assistance.
Quick & Dirty Summary:
Much of this article is about partnerships, with a summary of the benefits of LLCs at the end. This is so that you can fully understand the potential dangers of working in an unmodified partnership, and better understand the benefits a LLC brings to the table.
Joint creative efforts have created some fantastic works in the entertainment industry in particular, but joint ventures are not to be entered into lightly, nor without planning. There are common pitfalls that can be avoided if the proper steps are taken to ensure things are spelled out in how the partnership will work.
What is a Partnership? How do I know if I’m in one? Is it bad?
What it is: It’s a business entity. If 2 or more people go into business together for profit, you’re in a partnership. It doesn’t matter if you’ve sold anything yet, but if the ultimate goal is to make some sort of profit from your joint work, you’re in a partnership. This goes for making a game, writing a screenplay, or opening a lemonade stand.
How partnerships are formed: This is the most dangerous part of working with others on a project (without a partnership agreement/business plan), is that they’re so easily created. You can enter a partnership just by your actions, but also with a formal agreement. See above for the kind of action required to form a partnership.
Are partnerships bad?: Not at all, they just carry a potentially large amount of risk (financially, usually) if they’re not dealt with properly. And by ‘dealt with’, I mean either having a written partnership agreement or incorporating into a limited liability company (LLC), which would force you to write up your business structure anyway. I won’t go into C-Corporations here, because that typically takes a lot more startup money, which means you’ll already have a lawyer and won’t need the information on this blog.
What are the benefits and risks of a partnership?
Benefits of a Partnership:
Some benefits of a partnership are ones you’re likely already aware of, since you already gathered great creative people to work with you on your project. More people with differing backgrounds and expertise can really add to the final product, and you equally share the costs and profits of your project (assuming there’s no written agreement saying otherwise). Partnerships are also taxed the same way as an individual, and you have a lot of flexibility in how your business will run. It also requires 0 paperwork to form.
But, that’s also the problem, because getting out of a partnership once it’s formed can be difficult to prove, which is especially an issue for game devs who want to quit a friend’s project to pursue their own…and if that new game is remotely similar to the partnership’s game.
Risks of a Partnership
The risks of being in a partnership, however, can outweigh the benefits because of how quickly things can go cattywampus.
You and all of the partners in the partnership are PERSONALLY LIABLE for what THE OTHER PARTNERS DO—this means that if someone acted on behalf of the partnership (e.g. rented office space for you all without telling anyone or ordering 1000 high-end computers), YOU are legally liable for their actions as if you did it yourself. Typically this means you’re equally financially responsible for their actions as they are, even if you had nothing to do with the deal they made on behalf of the partnership. But, if you’re the one who has money saved up and your partner is broke…guess who is going to foot the bill? Also, partnership liability isn’t just limited to financial actions…it also includes criminal activities, debts, etc. by the others in the partnership.
To be clear: being personally liable means that if you are sued for a debt created on behalf of the partnership, and the partnership doesn’t have the funds to satisfy it, the person/company suing you for payment can come after YOU PERSONALLY. This means they can get at the money in your checking and savings account, foreclose on your house, repo your car, etc. until the debt is paid. LLCs, another business entity discussed at the end of this article, can serve as a protective barrier to this kind of liability.
Also, without a proper contract or partnership agreement in place, you may not actually own all you think you do, because the default state of a partnership is equal shares of ownership, profits, and losses. Thus, if you’re the one who owns the game, and you brought in a a friend onto the project as a partner, they could get equal shares of profits and possibly intellectual property ownership, even if they didn’t do anything more than convert oxygen into carbon dioxide at your office. So long as they HAD THE ABILITY to manage the business, if they wanted to, then a partnership could be found. There are some serious copyright ramifications as well in working on a project with more than one person, but I’m not going to cover that here. Look at my article on copyright law issues to better understand the issues and risks associated with working with others.
Length of a Partnership
Okay, say you’re in a partnership, how long are you in for? The duration varies wildly depending on the project type. It could be for the entire time you run your game business, or it could be for a single project (e.g. a joint venture).
Quick note on joint ventures: They require (1) the members must have joint control over the venture even if they delegate the work; (2) must share in the profits of the undertaking; (3) members must each have an ownership interest in the enterprise.
Why bring this up? If a disgruntled friend you worked with in the past wants to get at your profits, they could find a creative lawyer who could argue your work together was a SERIES of individual joint ventures, rather than an on-going partnership for which they were kicked out of, which means you have to share your past/future profits with them, even if they haven’t worked on the future projects.
Who constitutes a Partner?
Say you paid someone to do work on your project, and you paid them with money you earned from the project. Are they now a partner? It depends on why you paid them. Usually, if someone you work with receives a share of the profits of a business, then they’re presumed to be a partner in the business UNLESS you paid them to:
- pay a debt
- pay that person as an employee or independent contractor
- pay rent to that person
- repay part or all of a loan
- sell the goodwill of a business
Also, some relationships will NEVER create a partnership:
Simple loans – if someone advances money, and they expect that money to be repaid, regardless of your success, they are a creditor, not a partner.
Mere investments – if someone invests money or property into your business for a percent of the profits, but they don’t have any power to exercise management or control over how your business is conducted, they are an investor, not a partner.
If you and your partners don’t spell out your rights and responsibilities in a written partnership agreement, you’ll be ill-equipped to settle conflicts when they arise, and minor misunderstandings may erupt into full-blown disputes. In addition, without a written agreement saying otherwise, your state’s laws will control many aspects of your business, rather than being able to control it yourself by having the rules spelled out in a formal document.
While it may seem awkward to ask whomever you’re working with—your best friend, spouse, or someone you don’t know—to sign a formal document when your working relationship is so new, it’s just good business sense to have everyone on the same page as to how things will run.
Remember, when everyone is broke, there’s rarely a problem but as soon as money/profits are involved (or a serious lack of money), relationships change. They may sour, emergencies may come up, and you will want to have these documents in place to preserve your—and their—interests.
How it helps: A partnership agreement allows you to structure your relationship with your partners in a way that suits your business. You and your partners can establish the shares of profits (or losses) each partner will take, the responsibilities of each partner, what will happen to the business (and the work you’ve completed) if the a partner leaves, and other important guidelines.
What goes into a partnership agreement?
This list is not exhaustive, but merely illustrative as to some pertinent topics to discuss in a partnership agreement. A lawyer will honestly be the best way to get exactly what you want. AND I DON’T MEAN LEGAL ZOOM!!!! If you haven’t already read my article on the subject, think of going to legal zoom and getting a partnership agreement as if you’re walking into a tuxedo shop with a blindfold. There’s a chance you’ll get a tux that actually fits you (e.g. a contract that is tailored to exactly what your business needs), but it’s far more likely it won’t suit (pun intended). Lawyers…believe me, they’re there to help, and it’s always better to get their input early on rather than after the $%*# hits the fan.
- Name of the partnership
- Contributions to the partnership from each contributor
- Allocation of profits, losses and withdrawals
- Partners’ authority
- Partnership decision-making rights
- Management duties
- Intellectual property ownership (and physical property, while you’re at it, like computers)
- Exit plan (what happens when someone wants out, or you want to kick someone out?)
Caveat (warning/exception) to partnership agreements: Agency laws.
Oh, agency laws, thou can be a right b*tch. With regard to partnerships, agency has to do with who has the right to make decisions for your partnership. The agency authority is why partners are equally liable for everything the other partners do–every partner is an agent of the partnership, and thus can make decisions or contracts on behalf of the partnership. There are ways to limit that authority, but first you need to know what kinds of authority exist. There are 3 kinds of authority in which partners have the right to make contracts on behalf of the partnership (oh God, I’m having bar exam flash backs):
- Express Authority – there is a written agreement allowing for those kind of actions
- Implied authority – Implied authority is such authority that the partner reasonably believes they have as a result of their position within the corporation. For example if you formed a partnership and you’re an artist or programmer with no business background, and your partner is the business person—the business person is implied to be able to make business contracts just the same as you, even if it’s not written down.
- Apparent Authority – Apparent authority exists to protect innocent third parties who reasonably believe the individual with whom they are contracting has the power to enter into such contracts, or that the corporation is holding out that individual as having such power.
Imagine a representative of a small publisher hands you their business card which says “publishing director” or “licensing manager.” Wouldn’t you assume they have the ability to make a binding contract with you? Here, the law is interested in protecting the unaware third party—you, in this example—from having unenforceable contracts with people, and suffering a loss because of it.
On the flip side, you may want to limit what kinds of transactions your partners can enter into on behalf of your partnership, since you’ll be legally liable for anything they do, and any contracts they enter into. This whole article discusses the importance of putting your goals into an agreement, and this aspect is no different.
An agency limitation clause can include just about anything you want (and the other person is willing to sign). You make the choice of how the partnership will be run, who can make which kinds of decisions (i.e. licensing/contract/business, supply purchases, talent recruiting/signing, etc), and then you put that down in writing. Recording the exit strategies are incredibly important so that everyone is on the same page in the event someone wants to leave the partnership, or you want to kick someone out.
While it might be a pain in the beginning when relationships are still new and untried, in the long run, determining up front who has the power to make decisions and expenditures can avoid many problems.
Avoiding Inadvertent Partnerships
As for the discussion about partnerships, how easy they are to enter into, and how problematic they can be if they sour, remember that you can protect yourself by getting written agreements up front with the people you work with on major projects.
You should strive to write down the material terms of any project that you’re working on with someone who (A) you may get into a personal conflict with in the future or (B) is making a deal with you that involves a lot money or complicated conditions
Practically, small projects that won’t generate enough money to spark a legal battle or personal conflict may not be as important to get a written agreement for if it may be difficult or impractical to do so. Nevertheless, you should make sure that you and the person you’re working with are very clear on the terms of your deal before you begin.
These agreements don’t have to be typed, they can be completely informal. Signed agreements are much better, but even an email that lays out the terms of a deal and then asks the other party to “agree” is better than nothing.
LLCs – WHAT, WHY, & HOW MUCH?
Okay, you’ve waded through the risks of partnerships, now it’s time to briefly discuss LLCs (limited liability companies).
If you create a LLC, it acts a legal entity and barrier for debtors and creditors to go after. Once the funds and assets of the LLC are exhausted, if the debts of the LLC are not fully satisfied, then the creditors cannot come after your personal assets or money. There are exceptions to this, of course, and other means for which they can get money, but generally, this is the case.
That’s the main reason to form a LLC. Other benefits are a more formal structure (e.g. you HAVE to file articles of incorporation, which tend to prompt you to really think through your business plan), they have the tax advantage of partnerships (as opposed to corporations which are taxed twice), and they’re nearly as flexible in managing as a partnership (whereas a C-corporation has to have a board of directors, share holders, annual meetings, and quite a bit more money and government scrutiny).
S-Corp — have you heard of that term? It’s not actually a different TYPE of corporation, it’s a type of TAX STATUS for a corporation. It’s usually something veteran investors and business people use when they need to offload some income, so ask a lawyer if it’s something you need or should consider doing.
If you scroll up, the first thing I stated as a risk of working in a partnership was the PERSONAL LIABILITY. They can get your money, your house, your car, etc. to satisfy the debt. NOT SO WITH A LLC. A LLC works like this:
This is a generalization, and assumes you aren’t naughty and break the laws allowing for piercing that protection (Google ‘piercing the corporate veil’ if you’re curious).
Filing fees depend on your state and when you file. From what I’ve researched, it can range from under $100 to a couple hundred bucks. There are other costs associated with maintaining a LLC (taxes, insurance, etc.) to consider as well.
Terms to look up when deciding to form a LLC:
Articles of Organization – usually a fill-in-the-blank form provided by your Secretary of State; it’s the form you file to officially tell the state you’re making a limited liability company
Operating Agreement – Best to have a lawyer draft (or at least review) this, because it’s where all the planning goes for how you want to run your business, who gets what, who owns what, how people are added, and how people can leave the company (and what happens when they do).
If you’re wondering whether or not to incorporate in Delaware, whether because someone told you that’s the safest place or best place for businesses, read this article to just be aware that there are some downsides to filing in Delaware if you don’t currently live or operate out of the state.
If you’re starting a business to sell a game (or anything), you should also check out this site to determine what business licenses you might need.
If you’re a game developer, working with one or more people on a game from which you ultimately plan to make some profit, you’re likely already in a partnership. It doesn’t matter what you call it, because it’s your behavior when working with others that legally defines whether or not you’re in a partnership. But, there are ways to manage the risk (partnership agreements or forming a LLC, which is effectively a much more professional version of a partnership agreement and offers less personal risk) and you should consult an attorney to take the next step in being a responsible (and potentially more profitable) business owner.