Secrets of the acquisition process from EA and Zynga (straight from the horse’s mouth!)

The corporate development folks over at Electronic Arts and Zynga shared some insider advice last night on how the acquisitions process works at both companies.

I’ve excerpted some advice from the panel, which was held last night at Pillsbury, a law firm in downtown San Francisco.

Michael Chang, a director of corporate development at Electronic Arts, Grant Olsen of Zynga’s corporate development team, Jeremy Liew, managing director at Lightspeed Venture Partners and Mark Otero, who was CEO of KlickNation, a core gamer-focused company that Electronic Arts bought for the Bioware label spoke about how these deals are done.

Some key takeaways:

1) Be extremely careful about your early agreements, especially with game publishers: Sometimes publishing arrangements that contain options on future games can kill deals because acquirers want teams to work on their games right away.

“With some companies, there have been publishing arrangements that made it unpalatable for us to go forward,” Chang said. He gave an example of an unnamed company that had signed a deal for three games. “We needed to use them immediately, but that deal locked them up on three more titles. That left them with very limited options.”

2) It’s worth it to spend the extra $1,000 on a competent lawyer who can get contracts done correctly: All of the panelists said poorly designed contracts can kill an acquisition if the entrepreneur isn’t careful about how they’re structured. “Even some kind of invention agreement can seem really innocent, but come back to hurt the company later,” Zynga’s Olsen said.

3) Choose your investors wisely, because they can kill the outcome that you want: This is obvious, but there were some stories from the panel that were interesting.

Otero said KlickNation had raised about $100,000 after unsuccessfully making dozens of Facebook apps. In retrospect, the terms were bad because they gave Otero’s angel too much power over potential exits. It was a convertible debt investment with an interest rate and a minimum that ultimately gave KlickNation’s angel 10 percent of the company. (I reported that the company was sold for $35 million in December, including retention. Based on the structure of the deal, the angel likely had a 20X return. While Otero didn’t name names, the only angel in the company that was publicly known was Robert Simon at Ariva Partners.)

There were also veto rights associated with exits.

“Looking back, I kind of scratched my head. What the hell was I thinking?” Otero said. “I didn’t realize how powerful that veto right was when we were in the process of entertaining term sheets. It had tremendous power. It forced us to look at deals we didn’t want to do. I felt so powerless and helpless.”

At one lunch, he and his angel had such a contentious argument that they started yelling at each other. He said, “I told him I could not do this deal and he threatened me back. We both just walked away.”

Otero said he originally took the investment after several unsuccessful attempts at building basic, “spammy” Facebook apps that didn’t produce meaningful revenue.

“We had 30 failures,” he said. When KlickNation got to its 31st app, it started going into games that focused on more hardcore players — an idea that wasn’t proven at the time since the biggest developers on Facebook like Zynga were targeting casual gamers.

“There were whispers that core gaming would work. But we didn’t know. We just decided to give it shot. We launched in June and never advertised,” he said. “But the algebra began to work. Our topline revenue were was offsetting revenue. This was the Holy Grail.”

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