Employee Profit Sharing Plan

Game development is hard. It’s not just hard on you; it’s hard on your friends and family too. You do it because you love the challenge, the energy, the creativity, and the passion of making games; but it’s also nice to know your hard work will be rewarded if you make something exceptional. Giving you a meaningful share of the games you make and rewarding you for excellence is the goal of this plan.

This document is written to provide an overview of the Undead Labs profit sharing plan in clear language that we mere mortals can understand. We encourage you to read the formal document that describes the full plan in legal terms as well.

Goals

Eligibility

All full-time employees are eligible to participate in the plan. Your participation in the plan vests from your start date over the subsequent 24 months. For example, after one year of employment you will be eligible to participate in the next profit sharing round at 50%, and after two years of employment you will be eligible to participate at 100%. Of course, if you leave the company for any reason you will no longer be eligible for the plan.

Pool Calculation

For the purposes of calculating the profit sharing pool, we consider October 1 through September 30 to be our “profit year.” This allows us to announce and distribute any profit sharing amounts before the traditional (and traditionally expensive) end-of-year holiday season.

One of the trickiest parts of any profit sharing plan is determining how profit is calculated. Part of the problem is that the definition of “profit” is somewhat ambiguous, and this sometimes leads to misunderstandings. We define profit by the more formal accounting term “net income,” or less formally, “the bottom line.” It’s all the revenue generated from our studio’s products and services, such as sales of games, digital items, dev-team action figures (sure to be popular), and of course royalties from Hollywood to use our IP (Uwe, we’ll be in touch... ); minus all of our costs, such as payroll, taxes, rent, utilities, insurance, outsourcing and professional fees, recoupment of development advances, and publisher and distributor royalties.

It’s easy to calculate the profit generated during the previous profit year, but this number alone is not a sufficient basis for calculating the profit sharing pool.

Consider an extreme scenario in which we spend $10,000 a year for ten years developing our Nuke Dukem To Eternity MMO. When we release the game in 2020, we generate $60,000 in revenue from sales of in-game bullets, and our costs stay the same at $10,000, so our profit for the year is our revenue minus our costs, or $50,000. So, we’re profitable, right? Unfortunately the answer is no, because we have not taken into account the $100,000 we spent over the previous ten years developing the game. Our cumulative profit is actually $60,000 in total revenue minus $110,000 in total costs, or a $50,000 loss! Of course, if we generate $60,000 in revenue again the following year we would break even, and the following year we would have a $50,000 cumulative profit.

In short, we need to be cumulatively profitable, rather than profitable for a specific window of time. We accomplish this by calculating our profit sharing pool based on the lesser of the profit generated during the previous profit year and the cumulative profit over the company’s lifetime.

At the other end of the scale, let’s consider a hypothetical scenario in which we spend $5,000 over two years to develop a small console game, and release it at the beginning of the third year. Over the third year we generate $12,000 in revenue. We are also staffing up to develop a new game, so we spend $6,000 on R&D during the year. At the end of the third year our annual profit is $12,000 minus $6,000, or $6,000; but our cumulative profit is $12,000 minus $5,000 (R&D costs in year one and two) minus $6,000 (R&D costs from year three), or $1,000, which is less than our annual profit, so we’ll base our profit sharing on $1,000. In the fourth year we generate $10,000 in revenue with $6,000 in costs, resulting in an annual profit of $4,000; but now our cumulative profit is $5,000, which exceeds our annual profit, so we’ll calculate our profit sharing pool based on the annual profit of $4,000.

Year 1

Year 2

Year 3

Year 4

Revenue

0

0

12,000

10,000

Costs

2,000

3,000

6,000

6,000

Annual Profit (loss)

2,000

3,000

6,000

4,000

Cumulative Profit (loss)

2,000

5,000

1,000

5,000

Profit Basis

0

0

1,000

4,000

Profit Sharing Pool

0

0

150

600

It’s very possible that in the future we may have years that are not profitable, but we remain profitable on a cumulative basis. While we won’t distribute profit sharing during those years, we will be able to distribute full profit sharing in subsequent profitable years since we paid for R&D costs from our accumulated profit and won’t be recovering R&D costs.

Now that we have a basis for profit, we simply allocate 15% of that amount for the profit sharing pool. Using our previous example, the profit sharing pool would be $150 in year three, and $600 in year four. The remaining profit is reinvested in the company to fuel new game development, build a war chest for new opportunities, and maintain a pad for rainy days.

Distribution

If there is profit to distribute, whether from revenue generated during the previous year or residual payments from the profit escrow account (discussed below), we will distribute it before the second payroll of November. So that you can plan, we will announce the size of the profit sharing pool to the company a few weeks in advance of payroll. The size of the pool will be expressed in weeks of salary, e.g. “Thanks for the hard work everyone. Profit sharing for this year is ten weeks of salary. Now get back to work.”

We determine your amount by adding up the salary of every eligible employee in the studio and dividing your salary by that number, which determines your percentage of the pool. For purposes of this calculation, your salary is determined by the amount actually paid to you during the profit year.

For example, if you make $100 a year (mwah ha ha), and there are five other employees making $80 a year (mwah ha ha), the total of all salaries would be $500. Dividing your $100 by the total $500 results in a 20% share of the pool. If the pool is worth $1,000, your share would be 20% of $1,000, or $200.

There are no hidden mechanics or special allocations set aside for distribution “at management’s discretion.” Such mechanisms reduce the transparency of the plan because they have to be hidden from view. Worse, they introduce nasty politics into the system, because suddenly you have to be “in with the boss” to be part of the super secret extra payout. Our distribution mechanism has been carefully crafted to avoid these issues, by distributing the entire pool simply in proportion to your salary.

Escrow

Profit sharing plans make everyone happy when the amount of profit is sane. But what if we generate an insane amount of profit? What if, relative to the numbers being thrown around here, our revenue was One. Million. Dollars? (Basically meaning your grandmother, and all her friends, and Hillary Clinton and Joe Lieberman are obsessively playing our games.) This is where profit sharing plan proposals traditionally start to fall apart.

Let’s tackle this head on: Business types don’t like the idea of uncapped profit sharing, because they don’t want you to cash out and retire; or worse, cash out and start a new studio. You don’t like the idea of capped profit sharing, because you don’t want to bust your ass to create something awesome and then watch said business types enjoying their vacation home in the San Juans while you are still sweating to make your next rent payment.

The key to the resolution lies in the fact that the issue is not how much you are paid, but instead how much you are paid at one time. We can solve this with a profit escrow account.

The profit escrow account holds excess profit from one profit year and distributes it during subsequent years. The excess threshold is 200% of total studio salaries. When the size of the profit sharing pool in one year is larger than the threshold, the excess amount is deposited into the profit escrow account. When the size of the profit sharing pool is less than the threshold, any funds in the escrow account are withdrawn and added to the pool, up to the threshold amount.

As an example, let’s assume we have ten employees each making $100 a year, for a total studio salary of $1,000. Let’s also assume we have calculated a profit sharing pool of $1,200. The profit sharing pool is 120% of the total studio salary, which is below the 200% threshold, so the full amount is distributed to employees. In the next year, the profit sharing pool is $3,000, which is 300% of the total studio salary, so the amount that exceeds 200%, or $1,000, is deposited in the profit escrow account, and the remaining $2,000 is distributed. In the next year, we determine the profit sharing pool to be $1,500, so $500 is withdrawn from the escrow account to bring the profit sharing pool up to the 200% threshold, and $500 remains in the escrow account for the next year.

Year 1

Year 2

Year 3

Profit Sharing Pool

1,200

3,000

1,500

Profit Escrow Contribution

0

-1,000

500

Profit Sharing Distribution

1,200

2,000

2,000

Profit Escrow Balance

0

1000

500

In another example illustrating the “extreme” success case, let’s assume we have ten employees each making $100 a year, and a profit sharing pool of $10,000. $2,000 is distributed immediately, and $8,000 is deposited in the profit escrow account. Assuming the number of employees stays constant, we would be able pay the maximum distribution for the next four years, even if we did not have additional profit during those years. That equates to a total compensation of 300% of your salary for four years if you remain at the company.

This mechanism allows us to offer an uncapped profit sharing plan, while giving our financial partners confidence that we’re here for the long term.

It’s important to acknowledge that over the life of a company the leadership can change, the owners can change, and the direction of the company can change. While there is no way to insure against this, we can certainly do our best to ensure that the profit escrow is not subject to any company’s or person’s desire to use the funds for purposes other than those outlined here. Undead Labs will therefore establish the profit escrow account on behalf of its employees and appoint a trustee for the account. Undead Labs, its partners, subsidiaries, and investors will retain no ownership, control, or interest in the account. Only the trustee can make distributions from the account per the provisions of this profit sharing plan. These measures will help ensure that the account is used only for its intended purpose.

Finally, any interest earned by the profit escrow account is first used to pay administrative fees associated with the account, and the remaining amount is reinvested into the account for distribution to employees in future profit years.

What Now?

Now that we’ve talked about what might happen, it’s time to go actually make it happen. We’re in this  to make great games that can become cultural phenomena. You can pour your passion, energy, and sweat into helping us achieve that goal with confidence that you’ll fairly share in the rewards.

To the Lab!

Copyright 2010 Undead Labs, LLC. All rights reserved.

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