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Four reasons why VCs won’t fund games companies

By on March 24, 2010
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Alice Taylor (of @wonderlandblog / Channel 4 fame) tweeted last week to ask why games companies couldn’t get VC funding in this country.

I promised an answer in the blog, and here it is.

The basic answer is that they can. However, most games companies (and, in fact, most wannabe entrepreneurs) completely fail to understand what investors want.

Almost all the time. I am continually amazed about little effort games companies put into understanding financiers. And then even more amazed that they get upset when they don’t receive investment.

Point 1: VCs don’t invest in projects

This is the biggest misconception of them all. Games developers are good at pitching projects. For three decades, the most successful developers have honed their skills at pitching to green-light committees at publishers. They are the only customers who really matter, financially, for an independent studio.

So developers polish prototypes. They hone game design. They convince the publishers that *this game* will be the GTA/Modern Warfare/Dragon Age* beater.

Investors don’t care.

Really, they don’t. And what’s more, they shouldn’t. Can an investor seriously claim to know more about what makes a good game than publishers? About what will sell and generate a good risk-weighted return?

An investor is dependent on the developer’s opinion, and frankly, developers have a habit of getting more excited about their concept than the market potential or financial return. (Which is fine, BTW, if you’re happy to outsource all of that stuff to the publisher, and let them take the lion’s share of the profit too).

Investors care about businesses; developers show them projects.

Point 2: Investors want to see a running business, not an idea

Many entrepreneurs (and pretty well anyone who is foolish enough to choose to appear on Dragon’s Den) think ideas are valuable.

Seasoned entrepreneurs know that they are not.

Ask yourself how many ideas there are for games – good games – within your development studio right now. Ten? A hundred? A thousand? I would bet that there are more great ideas than your studio could possibly develop in a century.

The same is true for investors. They see hundreds of great companies every year, who are already executing on an idea. They see more wannabe entrepreneurs than that, all of whom get frustrated because “if only they had the money, they could turn this brilliant idea into reality.”

Entrepreneurs don’t wait for the money. They do it anyway.

Point 3: VCs want sustainable businesses

Traditional games developers are really difficult for any investor to fund. They look like quite late-stage businesses: they may have hundreds of staff, millions in turnover and a proven track record. But fundamentally, they are always just one deal away from bankruptcy. They look like startups from a risk perspective but are like late stage investments from a reward perspective.

Games developers always think that VCs want too much of their equity; VCs think that the risk is so high they need a huge slug of the company to compensate them for the risk they are taking. There is rarely a meeting of minds.

Broadly speaking, traditional games developers are just too risky for VCs.

Point 4: History sucks

Just taking British examples, investors have seen failures in Warthog, Argonaut, Elixir… They’ve seen poor returns from Lionhead and Kuju. Talking to investors a couple of years ago and they shook their heads sadly about the games industry, saying it was just not for them.

The good news

Investor perception is changing. In fact, I would go so far as to say that we are about to enter another bubble, where too much money is chasing too few assets, and in the ensuing carnage, margins will be competed away, bad companies will survive for too long and good companies will die through hubris and bad luck. (But that’s a topic for another post).

However, for traditional games developers, the news is not all good. Investors don’t want AAA content. They don’t want games that are products, whether those are on console, PSN/XBLA or smartphones.

They want Games As A Service. They want ongoing revenue streams. They want virtual goods. They want free distribution with an upsell model. They want browser-based games.

There is a wall of money flooding into games right now. It just ain’t coming to console.

* * *

Tomorrow, I’ll post about the difference between seed, Series A and Series B funding, why it is so misunderstood by games companies and how getting the wrong investor at the wrong time can destroy your company.

* delete according to your genre preferences

About Nicholas Lovell

Nicholas is the founder of Gamesbrief, a blog dedicated to the business of games. It aims to be informative, authoritative and above all helpful to developers grappling with business strategy. He is the author of a growing list of books about making money in the games industry and other digital media, including How to Publish a Game and Design Rules for Free-to-Play Games, and Penguin-published title The Curve: thecurveonline.com
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  • Thanks for the comments guys:
    @ Thomas, Paul – The misunderstanding on both sides is staggering. VC is called for when you know *exactly* where you are going and need to get there faster. It can be very dangerous for games companies who are still figuring out the direction

    @Nigel I still think that VC will be slow to come to console. Console games inherently require more money (due to expectations of consumers and requirements of the platform owners) and are risky because you operate at the whim of the platform holder. (and before you quote Facebook back at me, Facebook operates an open API and its success is predicated on open access – that is not true for consoles).
    It's not that I don't think free is coming to consoles (I do). It's just that it will be more expensive to make, addressing a smaller market limited by the need to spend $400 on a piece of hardware compared to free on the web

  • Nigel

    Great post, although the signoff (“It just ain't coming to console”) seems like a leap.

    Are the models mentioned in the second-to-last paragraph (games as service, ongoing revenue streams, virtual goods, freemium) inextricably linked to browser-based/Facebook/iPhone games? Can they never work on console?

  • Great (and wonderfully succinct) post. It was interesting to hear some VCs at GDC talk as though the Facebook games ship had already sailed from an investment (at least early stage) perspective, with the entrance of the big players (cf. EA) sparking more intense competition, higher barriers to scale, lower margins and industry consolidation – fewer opportunities for VC-style participation.

    That's not to write off games as a service as a whole – there'll be new distribution channels for early movers and their backers to (temporarily) own, but I wonder whether the serious money will go elsewhere (monetisation platforms, 'gameification' ventures) over the next couple of years.

  • Good post Nicholas and certainly reflects our experience on the ground. The best way to learn what VC's are looking for and to judge whether that direction is right for your business is to talk to them… and often! Still surprised how many games company CEO's complain of a lack of capital but have never actually bothered to speak to any VC's… all the while bemoaning the publisher model. Still good news about the tax breaks isn't it? Isn't it? Perhaps you could share your thoughts on that news at some point soon as well?

  • I agree on all 4 points.
    I will also add that very few VCs understand the new era model (web in general but very true for games as well), where actually cash influx doesn't help scale growth the way it does in more traditional industries…
    That can make VC actually dangerous as partners, and have them push for the wrong decisions. A few examples: Funcom, Spellborn, Monte Cristo…
    And I don't think VCs in general have reached the maturity to understand Game as a service; most are still looking at investing in platforms (and technologies) for their current investment.

    Looking forward tomorrow's post.