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50 questions: What are the different types of early stage funder?

By on November 24, 2010
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Yesterday, I co-hosted (together with Paul Gardner of law firm Osborne Clarke) a roundtable discussion between VCs and a number of games entrepreneurs. You can read Nic Brisbourne’s thoughts on the event in a post entitled VC investment in the games industry on the Equity Kicker.

I was struck by how, even with only five investors in the room, we had a wide variation in attitudes to risk, the market and what makes an attractive investment.

So, as question #4 in off this series of 50 questions you should ask when raising venture capital, written jointly with Nic Brisbourne of DFJ Esprit, and as a follow-up to my post What exactly is an “investor”?, I wanted to write about different types of early stage funder.

Nic has already addressed the question “Is venture capital right for your company?” I want to go one step further: if VC is right, what type of VC is best; if VC is not right, what are your alternatives?

Revenue, revenue, revenue

Revenue is the cheapest form of finance. It requires you to pay no interest nor to give up equity in your company to an outside investor. It is, in many ways, the best form of finance. For most early-stage companies, it is also the hardest.

I haven’t got time to go into detail about how you generate revenues from a games company in this series (I cover it in detail in How to Publish A Game, which is on sale at a 50% discount until 7th December), but let’s go over the general idea.

You can generate revenues by boot strapping or calling in favours. You can do work-for-hire for game publishers (like most developers), for advertisers (like Fishlabs and nDreams), for education providers, for government (like Blitz), for television and entertainment companies (like the dozens of British game developers working for Channel 4).

Then you self-publish something – anything – in the gaps in-between projects. You learn, you prosper, you grow. Eventually, with blood, sweat, toil and tears – and quite a bit of luck – you will be able to wean yourself from pitching projects and become a self-publisher. It will be slow, and hard work, but it can be a viable alternative to external financing.

Other sources

if you are not ready to make revenue your primary source of capital (and for many startups, it is incredibly hard), there are alternatives:

  • Banks: if you just snorted into your coffee as you read this, I’m not surprised. For a games company to get money from a bank is very, very difficult. Our business (like most startups) is risky, uncertain and dangerously likely to default; games are even worse because they carry creative risk as well as business risk. Banks will typically ask for a business loan to be guaranteed by the directors personally. In the UK, the Enterprise Finance Guarantee provides government backing for 75% of the value of the loan – although even these are hard to get.
  • Government grants: These are often very specific by country, region and even city. It helps if you are in an area that is viewed politically as being in need of regeneration (it is easier, for example, to get a grant in Scotland or the North East of England than in London). The secret to securing these is to be in the regional networks that fund these type of projects. As you will discover throughout this series on raising money, networking furiously is your best chance of sourcing capital.
  • Funds: The games industry, in particular, is full of specific funds that want to put small amounts of money to work on games. Kleiner Perkins runs the $200m iFund and the $250m sFund. The developers behind World of Goo and Portal have launched an indiefund to help develop new and interesting games. Companies like Mochi, Sony (a very specific offering called the PubFund) and Channel 4 (through the now defunct 4iP) fund games directly. There is no easy way to find all of them – although I am starting to build a resource to list all the ones I know on GAMESbrief. Do let me know if you know of any others.
  • Sell your house: It worked for Sean Murray of Hello Games. He made Joe Danger with it. I’m not sure I would recommend it though.

No, really, I want VC money

If you’ve decided that you really do want VC money, you need to start understanding the motivations of the investors. Not only are there a lot of terms bandied about, but investors often all sound as if they are saying the same thing – until you’ve spoken to enough of them to understand the nuances. (I’m sure investors say the same thing about developers). There are a couple of key aspects you need to focus on.

What stage are they?

Angels. Superangels. Incubators. Early stage VC. Growth capital. Late stage growth.

Investors will describe their investment philosophy in many different ways. The crucial thing to identify is what level of risk they are comfortable taking:

  • Are they backing three people with an idea? (very early stage. Often angels or a handful of high-risk, high return funds)
  • Do they want to see a solid team and clear evidence that a market need exists, which is typically evidenced by the existence of paying customers? (early stage VC, growth capital)
  • Are they reluctant to invest until you have $2m of revenue and a clear growth strategy? (Late stage growth)

The only way to find this out is to talk to the investors. Worse than that, you have to keep talking to them: one VC I know has just made a decision only to invest in later stage companies at this stage in its fund, in direct contrast to its investment philosophy less than a year ago.

Risk/reward appetite

All VCs talk about wanting to invest in the next Google; few are actually prepared to take that level of risk. In the UK, in particular, investors look for clear evidence of revenue and financial growth, rather than following a strategy of “get big as fast as you can, worry about the revenues later”.

I’m not against this (I was an equity analyst during the dotcom boom and saw what happened when people stopped thinking that having a viable business model mattered at all). But if all VCs say that they are swinging for the benches, and then encourage you to take the safe path, you might be forgiven for thinking that they were saying one thing and then doing another.

How do I navigate this confusing maze?

I’m afraid that there is only one way. Get out there and meet people. It can be at conferences or at networking events. It can be via their blogs, twitter feeds and newsletters. It can be over the phone or in person.

If you are looking for funding, you need to be out looking for funding. Even better, you should start this process 6-12 months before you need funding. (Mark Suster has a great post on why this is true called Invest in Lines not Dots.)

It is not as bad as it sounds. But you should expect to invest as much time in learning about the world of the funder as you expect them to invest in learning about you. If you don’t, you are likely to be very disappointed in the outcome.

Hungry for more? Go to the 50 questions homepage for more insights into venture capital.

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