Gaming allocation strategy, portfolio construction, and underwriting
How a gaming allocation fits into an overall balanced alternatives portfolio, and what its holdings translate to
One of the members of our limited partner advisory committee (the equivalent of a Board for our fund, composed of some of its biggest investors) put it well: early stage gaming should be a small portion of a balanced alternatives portfolio that you don’t touch for nearly a decade as you wait for it to mature, and when you do, it should have grown exponentially. Put a dollar in, let it sit for a while, and get several or more back.
Whether through the lens of a large institutional family office, or varying degrees of high net worth, the alternative/private asset portion of a portfolio is going to have a wide variety of vehicles in it with varying degrees of risk, time to maturity, theme, etc. Though investing in gaming startups via a portfolio approach with a significant number of holdings per fund does de-risk the value proposition to a degree, investing early always carries risk given the failure rate of technology startups in general, and the thematic concentration in a single sector- let alone one as competitive as gaming given that ultimately it is a consumer market based on choice and wallet share- only increases it.
The return potential of even a small amount of capital relative to the overall size of an alternatives portfolio, of course, is what compensates the allocator for the risk. At the fund level, investing several million dollars for double digit % ownership into a studio
that properly leverages the power of the cloud, development engines, and the latest in tech (e.g. generative AI) to ship product;
with an elite leadership team and top individual contributors in place;
and has a strong prototype foundation
can translate to a return of many multiples over 10 times initial investment. One or two small institutional rounds (ten million or less total invested) can be enough capital to fuel a multi-hundred million+ dollar return; fold 10-20 of these bets into a well-managed fund and you have a composite asset that incorporates the potential for massive upside return via even just a single “venture-scale” win.
The return profile is really no different than your typical early stage fund that returns orders of magnitude of invested capital via the power law; the difference lies in how that return is generated and the nature of the environment in which it occurs. Several environmental dimensions unique to the gaming vertical must be successfully navigated to achieve a venture return. The sector retains many of the same challenges as other venture-backed verticals, and has some of its own in addition— none insurmountable, but all requiring careful management.
Content investments (i.e. into companies developing a game) rely on correctly assessing a founding team’s ability to deliver on both the “art” and “science” required to achieve traction with players. Go-to-market expertise, technology architecture and execution, and both visual / gameplay design all must work in concert, and even when executed flawlessly may still not strike a chord with consumer sentiment. This is a matter of being able to attract veterans with the right skill sets, integrate them into a team, meld them into a team, and execute on art, design, and technology workstreams in parallel during production. Despite the amount of research, prototyping, demographic testing, and iteration based on soft launch analytics, there still remains a significant component of creative agency to the development process, which can never rely entirely on data to inform design and artistic decisions.
A corollary to this need to successfully integrate “art” and “science” internally to execute a successful development process exists on the go-to-market side in terms of what it takes to gain traction with players: the technical and design sides of the value proposition “coin”. The bar is high as far as the level of service expected by the customer in gaming. The highly complex, always-on virtual space within a game must not only work dependably, but with very little latency (i.e. actions taken by players, whether in a game session, purchasing an item in the shop, interacting with friends, etc.) on the technical side; in terms of experience, it must balance the familiar with something that players cannot currently get from existing offerings. It is difficult to overcome a deficiency in one with strength in the other; a design with the right mix of familiar and innovation might grab players’ attention, but they will churn if the live service is unreliable, while a robust technical product that is either too unfamiliar for players to onboard or too bland against existing offerings will stagnate from lack of engagement.
Market timing, positioning, and iterating based on a robust analytics suite all help, but at the end of the day talent is the deciding factor in balancing this unique mix of creative and highly technical needs. The magnitude of the prize for successfully doing so in gaming thus engenders a constant war for talent between all the incumbents and upstarts across the industry. The latter do have assets at their disposal to compete with the former in terms of autonomy and equity to offer, but the former have near-infinite free cash flow and resources to go after top talent.
The only way for an upstart to have a chance to win at the end of the day and generate a venture-scale return, then, starts at the top with the founders. As we’ve discussed previously, the profile we seek to back is very narrow: those who have already successfully built one of these businesses to an exit, and want to go after win 1+N; and/or have built a multi-hundred-million-dollar+ gaming business inside a blue-chip incumbent and want to capture the upside for themselves. That track record is unequivocally the most reliable data point against which to underwrite the odds that founders can both manage a development process that achieves the above, as well as attract the varied skillsets required in the ranks to build and launch successfully under them.