3x markups, 2x funds, 1x firm

& how we think about portfolio construction in the gaming space

In previous posts we discussed the opportunities in gaming for venture returns; we'll now delve into the structuring of gaming specialist vehicles that invest into the vertical, including our own.

Though there are billions in AUM dedicating to gaming venture investment today, there is no single model for the firms deploying that capital. Below are several example types of funds and firms investing in gaming:

-several hundred million dollars marked for gaming within a multibillion-dollar generalist vehicle

-several hundred million dollars up to a billion dollars in a gaming specialist fund, either within a large generalist firm or an independent gaming-focused firm

-fifty to one hundred fifty million dollars in an independent gaming-focused firm focused on a particular thesis within gaming (only game development studios, only tech, only seed, etc.)

-sub-fifty million dollar funds with a narrower focus (e.g. only studios in a particular geography)

Portfolio construction in terms of investment stage, check size, and portfolio n-count is of course the biggest difference across the models of different sizes given the "power law" distribution of returns in a portfolio; a smaller fund typically writes smaller checks to allow for a enough investments (portfolio n) to cover the full spectrum of returns from zero to fund return+.

Our practice is relatively concentrated- making a few heavily diligenced "bets" with proven entrepreneurs as discussed in past posts, and then devoting significant resources to operational support. The fund we are currently deploying (also ~$60M) is projected to include 15+ investments. Today we are still managing the portfolio for the first fund we started back in 2019 and investing the reserves into pro ratas / growth, as well as actively deploying out of the second (EOY 2022 close) into new investments (portfolio projected to be ~7-8 depending on deal close timelines by end of 2023)

The funds are both focused on early stage single-digit $M investments, inherently early stage (first or second institutional round). Typically we look for double-digit percentage equity ownership, and the preferred director seat on an odd-numbered Board alongside founder common seat holders. Given the low n-count, we have to underwrite not only against a high expected value (% chance of success x size of outcome) due to the founder experience discussed in previous posts, an extremely large addressable market, and clear evidence of the team’s ability to execute (prototype and/or data), but our estimate of whether we can offer enough (and the right kind of) operational support to give the company anything it needs along the way. From a thematic perspective, the investment thesis encompasses content-developing studios (single or multi-game), platforms (such as user-generated content engines), or technology in gaming or gaming-adjacent spaces that can feed the industry (such as consumer entertainment IP).

So where do we fit in that list above? Size-wise we are in the fifty to one hundred fifty-million-dollar fund size / AUM bucket obviously, and like others in that bracket our thesis is bounded by a particular focus, but the nature of it is rather unique given that it is not primarily thematic but rather structural. No single variable in the structural thesis is unique, but the combination of the filters mentioned above (check size, ownership, BOD with founder XP, addressable market size, prototype/data) with our portfolio construction strategy makes us different. Though the average check size is small in the gaming venture spectrum, it is very large relative to size of fund, which leads to the aforementioned portfolio concentration (15 companies is a relatively small n for a venture portfolio) that allows us to deliver on an extremely high commitment of operational support.

Both funds are rather young; the final close for the initial fund we raised was in early 2020, and late 2022 for the fund out of which we’re currently deploying. The majority of our LPs in the current fund are the same as the first fund. Four years and change of investing across the two funds is a relatively short time in the lifecycle of early stage investments, which typically mature no earlier than 5-7 years post-investment, if not 10, but we’ve been fortunate to already have demonstrated several forms of early traction with the strategy that we had promised our LPs at the outset of both funds. We gauge success in the first few years post-investment according to whether our companies “cross the chasm” (previous post) from initial product development to early commercial traction.

For a given company, the “symptoms” of accomplishing such look like any the following:

-receiving an attractive acquisition offer from a strategic buyer that includes both a healthy upfront cash consideration and high upside earnout for both us and the company (we turned this down in favor of higher long term upside)

-hitting the multimillion-dollar revenue threshold within a year post-product launch

-achieving early profitability in tandem with rapidly growing revenues

-securing a key strategic go-to-market partner via a deal that includes an equity financing round at a higher valuation and/or attractive publishing deal and/or non-dilutive project financing

In terms of portfolio performance, the companies “crossing the chasm” with the above tend to raise new capital at about a 3x markup relative to the initial valuation, which equates to healthy TVPI multiples. As is always the case in venture, however, in the five to seven year+ timeframe only our DVPI multiple, i.e. money actually returned to limited partners is going to matter.

From a learnings perspective several themes have manifested across working with teams that have already crossed that chasm versus those that are still working on it. In keeping with the theme of his blog, of course (one of the big prompts for titling it The Botlane), whether or not there is a true “bot lane” duo comp among the founders & those getting the company off the ground has revealed itself to be an overwhelmingly important factor. That relationship can take different forms, but it still boils down to that combination of different skill sets and personalities that can enable and empower each other. Sometimes the role of “support” versus the outward-facing “adc” securing all the gold and kills switches between two parties depending on stage and situation, and sometimes it stays constant; regardless, having that dynamic (and how strong it is) has proven critical in our portfolio. We’ll run through various different forms it has taken among our portfolio in the next post.