I have spent the past few years thinking a lot on how to fund my game development in the future. This is the way I currently plan on doing business, and I would suggest all other independent developers move to a similar model if we are to continue making our own games, the way we want to make them. As a little background info, I'm working on my very first game right now, but it follows a slightly different approach since we have almost no budget to speak of and have not established ourselves in the industry yet. You may be quick to say "what does he know?" now, but I have been studying development practices and business models in the game industry for the past 10 years in preperation for now.
The current business model in the game industry promotes publishers to extreme realms of power even though they tend to have little to do with the actual games' production. It's a good bit like the model "old Hollywood" used before the 50's or so... Like game publishers now, the studios made the vast majority of the profits and the people who actually made the films got very little in return. Now a studio performs a much smaller role. They provide an investment budget (along with producers) and then help promote and distribute the films. It is fairly common for many of the actors and the production crew to make royalties in addition to their initial paycheck. My plan is very similar.
The first thing we have to do is put publishers in their place. They expect too much control over the games we make and the large number of crappy games released lately is a direct result of that. These people know about money, not art. And so that's all they should be concerned with and allowed to control. Many times the publisher will go as far as to buy the rights and trademarks to the game, its characters and name too. The developer tends to almost sell their soul to their publisher just to be allowed the privilege to make their game and then have it taken from them. This is not always the case, but it happens far far too much. The publisher should do just what its name implies, publish...and only publish. They should only concern themselves with the promotion and distribution of the games they publish. They may also want to invest money into the development of the games they publish, but this is optional and I'll discuss it more later. Once a game has been pitched to the publisher and the contracts are signed there should be little to no involvement from them in the development of the game. All they should be concerned with is publishing. And also since they are taking a much smaller role now, they will not get nearly as large a cut of the profits. The majority of the profits will go to the developers. I know you're thinking "no publisher will agree to this". And you are right if you speak of the current "big guys". The only way they will conform to such a model is if the entire development community rises up and forces them. Luckily, there are a few new publishers getting into the game these days that already agree with this model. Companies like O3 (On Our Own) Games are already out there ready to simply publish and not meddle with the development process.
Ok, so where does the money come from? Games are getting more and more expensive to create each year... What I propose is an distributed investment model. Think of it almost like shareholders and a corporation, but just for each individual title. We, as the developers, will have to have a little money flowing in already (or borrowed) to do this, but what you do is create a very basic prototype of the game. You draw up some initial story boards and game ideas; pretty much everything involved in preproduction. Then you come up with a budget. It is very important that this be a realistic budget. Now you start spreading the word that you need investors. You can pitch it to publishers if you want, but you must make clear that they are only investors and will have to give you the freedom to create your game the way you see fit. So what if no one wants to fund your game, but you think it's a winner? Fund it yourself. This may sound unreasonable, but by the end of this rant it shouldn't seem that far fetched. Most likely though you would want to do a mixture of the two. And here is the core of this model. The investment money acts like a deposit. Once that money has been paid back to the investors you split the profits 60/40 from that point on (60 being the developer cut). Why 60/40? Well, if you look at it from a utilitarian point of view, the game would not exist if you had not made it, so clearly the developer deserves a larger cut, but you wouldn't have gotten to make it if it weren't for the investment money. You may even want to split profits 50/50, but I think 60/40 is a very fair ratio.
This brings me to the third crucial part of the argument. The developer is now getting a rather nice cut of the profits (if we luck up and there are any), so how do you divide it? Ideally I would suggest only paying on-site staff royalties and set flat fees for any subcontracted/outsourced work, but you may find it better to split a little bit with them for a price cut. And this is where it all comes together. In the same way, you give your team a price cut. Your team gets paid a substantially smaller portion than the average developers upfront. If you have a programmer who would normally make 60-70 thousand at a traditional house, they will only get paid 30-40 thousand (maybe a little more, but it depends on your situation). BUT, by taking this smaller salary, your guys are also guaranteed a direct cut of the profits. Traditional publisher/developer houses could do this too, but they'd rather just pay their employees more, rather than give them a cut because it's usually less money that way. Because of this we only need around half the budget or so of what a normal company would. And so, because there is less investment risk, you now have a stronger control of the profits and creative freedom. Your developers make less up front, but have the potential to make much much more than they would have, depending on how successful your game is. Of course, you have to decide for yourself, but you will tend to want to divide your profit sharing by the basis of how much work each person did and how important their role in the development was. This also has another positive effect. Because the development team's pay is directly affected by the games sales, it will be more important to them that it is successful and they will feel like they own a larger portion of the game. This is very good for company morale. Now comes the other tidbit I mentioned earlier. If members of your development team invest money into the initial budget for the game then they not only get their royalties from making it, but also a cut of the investor profits. The whole point here is to make development a more personal process and keep as little money as possible tied up in abstract businesses. This also means you'll want to be very smart with how you spend your money during development. I would advise you to invest in using open source development tools (and contributing back to them when you can) and not buy the most expensive, be-all-end-all workstations. The less money your company has to spend on development, the better your chance for finding enough investors.
Yes, this business model is a little risky, but that's why it's called business. Especially in the entertainment industry, you are never guaranteed to be successful no matter how much you play it safe. Of course the situation I described is an ideal, so you'll need to be flexible; just don't let your publisher break you ;)