Earlier this month, Agnitio Capital founder Shum Singh hosted a panel at the Montreal International Games Summit to discuss the state of mergers and acquisitions in the games industry, and opened the presentation talking about how the pandemic boom fueled incredible M&A activity a couple years ago and gave everyone a story of some founder they knew who sold a studio for an unexpectedly generous valuation.
“Those were crazy times,” he said. “Unprecedented. We’d never seen anything like that. From pretty much the moment COVID began until the spring of 2022, when the world changed. Rather than focus on those crazy times, which to be honest were kind of an aberration, we’re going through a slightly different time right now.”
When Singh hosted a similarly themed panel at last year’s edition of the show, the boom was already in the rear-view mirror, with economic headwinds and rising inflation already areas of concerns that had cooled off the gaming sector as an M&A hotbed. The past year has only increased those headwinds, with Singh acknowledging unstable macroeconomic conditions, geopolitical risk, and instability hurting businesses across the board. Even so, he put a relatively positive spin on the situation.
“Let’s be honest, a lot of people over-hired during the boom years of COVID, and that’s what you’re seeing,” he said. “I don’t think this period is difficult, I think it’s just a rationalization. It’s just people trimming for a lot of massive growth they experienced for years. I still think as an industry, everything is great and is going to continue to look great. We’re just going through a bit of a pain period, a growing up period, whatever you want to call it.”
His own company Agnitio is a gaming-focused investment bank and already shepherded three deals to closure this year: Keesing Media Group’s pick up of CoolGames, Keywords’ acquisition of Hardsuit Labs, and The Sandbox’s deal for Sviper GmbH.
“Yes, all those deals took a lot longer, all those deals required much more time and effort in identifying who the right partners are,” Singh acknowledged, “but there still is plenty of cash, plenty of interest, and plenty of willingness to do deals on the part of not only strategic buyers that we all know, but also private equity companies and other large financial institutions that want to get exposure to games.”
To discuss the current state of gaming M&A, Singh had a panel consisting of Marc Alloul, Jakob Longer, and David Dropsy.
Alloul has seen seven start-ups through the sale process, including Complex Games’ sale to Frontier and Bight Games’ sale to Electronic Arts.
Longer was Rovio’s head of corporate development until September and saw the company through acquisition talks of other companies, as well as its own sale to Sega. He also served as chief of staff and director of mobile operations for Wargaming.
Dropsy is a partner a De Grandpré Chait, a Montreal lawfirm offering services in a variety of fields, including mergers and acquisitions.
Longer agreed with Singh both in his assessment of the underlying slowdown as well as the continued interest companies have in investing.
“There’s a general cautiousness in the market right now,” he said. “There is a bunch of cash that is needing to be deployed. There is a bunch of pressure to deploy that cash, go out and spend it because if it’s sitting in the bank, it’s not going to be helping anyone.”
Longer says the process for choosing what to acquire doesn’t really start with an assessment about the state of the economy. Instead, it’s more about strategy, with companies identifying what they want to achieve, what their business needs, and where it has gaps that an acquisition might fill.
“From that point onwards, you typically shortlist a most-wanted list of companies out there,” Longer said. “‘These are attractive. If we could wave a wand today and buy any of these – let’s not look at the valuation right now because that’s a later conversation – if we could buy them all, we would love to have them.'”
That exercise in itself can be an incredibly useful tool for leadership to understand what it’s chasing and what it wants from each potential target.
As he says, “Is it technology? Is it the team? Is it IP? Is it product? Are we buying revenue and profit, or is there maybe some other factor here which is super-interesting to the company? Every business has its own unique set-up, its own gaps, and its own unique most wanted list.”
He also acknowledged that depending on the answers to those questions, what an acquirer believes a company is worth can vary greatly from what the company’s owners feel its true valuation is. The acquisition sprees of previous years may have inflated expectations, but a disagreement on that front doesn’t necessarily mean all deals are off.
“The challenge at that point in time is do we focus on structure or find different ways to [do the deal],” he said. “Typically valuation doesn’t really shift a lot unless there’s a gross misunderstanding of the business and the fundamentals behind it. Where there can be flexibility is the structure. What this fundamentally comes down to is how we balance risk.”
That’s where performance-based earn-outs come in, and Longer said that’s the single biggest shift he’s seen in recent deals.
Dropsy then tied that shift to companies scrutinizing potential acquisitions more than they did a couple years ago.
“Due diligence will be really intense, and the terms of the deal will be really intense,” Dropsy said. “Banks are loaning at really high interest rates, and now the strategy of the banks is they’re looking for deposits, they’re not looking to loan money so there will be less and less of that. You need deposits to be able to loan.
“So the deal structure that’s going to happen is that purchasers will say the purchase price is X and you get 30% on closing and 70% in an earn-out, so you have to hit these financial milestones year after year for three, four, or five years to get your full purchase price at the end of five years.”
Dropsy added that buyers can get very aggressive with earn-outs these days, and that can definitely scuttle deals. Another option beyond the performance-based earn-out is a deal where some of the pay comes in the form of stock, but that also complicates the deal and makes it less of a true sale.
Longer said things had shifted quickly. Even as little as nine months or a year ago, there would be more competition among buyers and that meant deals went through quicker.
“You had multiple parties interested in the same target, and you had this general pressure that if you did not have the right deal structure and valuation before, then someone else would,” Longer said. “Now the power has shifted back to the buyer’s side. There’s less competition. The deals take longer. Buyers are more sensitive towards hiccups, loss of momentum, or any sort of red flags or amber flags that pop up during the process. The courting/dating process has gotten longer. It’s tougher for all parties.”
Singh added that buyers “play hot and cold right now,” playing potential acquisitions off one another and stringing deals along in the hopes that they can get better valuations from them, or greater commitments from the founders to be committed after the deal closes.
Alloul said founders need to understand why they are looking to sell as well. Is it just because they’ve taken the company as far as they can, or do they need external talent or an injection of new capital to open doors for publishing distribution, or user acquisition? He also said it’s important for entrepreneurs to know what kind of exit they’re looking for the same way a racer needs to understand why kind of race they’re running.
“What type of driver are you going to be?” Alloul asked. “What type of race are you going to embark on? Go-karting, Indy cars, NASCAR, or F1? These are not the same teams, not the same cars, not the same behaviors. You need to know which category you’re going to run in because it’s going to dictate the effort and rigor to build the company to sell at different levels.”
It’s the same with start-ups. The expectations are going to be a lot different for a founder looking to sell for under $25 million than one looking to exit for $250 million.
Whatever kind of race a start-up is running, Alloul stressed that it’s a good idea for the founders to have things in order and be “deal-ready” all the time. He recalled one time an investor was interested in taking a 10% stake in one of his companies, but wound up buying it outright after discussions began.
Longer echoed the importance of having things in order before deal discussions begin.
“It is incredibly important and can be a blocker at points when you start having conversations and the studio is missing documents, missing details, not projecting where things are going on their own side of things,” Longer said. “It comes across as sloppy… That’s when you see the buyers start to pull back. ‘OK, you don’t have your house in order. I’m seeing some problems early on. If we extrapolate that it could be a lot more problems down the road which the lawyers and finance team will dig up.’ And that all impacts the potential deal.”
Longer added that it’s better to be selling when the numbers are increasing and a studio has momentum on its side.
“When numbers are increasing and users are growing, that’s a great time to have conversations because then you’re the hot girl or the hot guy at the bar,” he said. “Everyone’s sniffing around, everyone wants to have conversations with you. You’re starting to sell what could be, not what the reality is. And that’s far more powerful for you on the side of the seller than is a situation where your numbers start to drop.”
Singh took a slightly different tack, saying the best timing for a deal could hinge not on the company’s trajectory but the founders’ personal situation, like their age or their desire for financial stability.
“There is no good time,” Singh said. “It’s all really based on your own personal and professional objectives, and that can change dramatically.”
Correction: This article originally misquoted Longer in the quote beginning, “When numbers are increasing and users are growing…” We have corrected the quote.
