What it takes for gaming venture-backed companies to “cross the chasm”
The path from first gaming institutional financing to securing launch/scale capital is a difficult one
We’ll use two examples from the portfolio to break down what it takes to successfully cross the big early “chasm” in building enterprise value in gaming - moving from ideation & initial build to securing go-to-market financing.
Though venture capital from gaming-focused vehicles has only been a real force in the vertical for approximately the past several years, a pattern is already emerging that is in some ways similar, and others different, to the value creation lifecycle in other venture-backed verticals.
Prior to 2019, the game industry grew at a massive clip without the aid of gaming-focused venture, and for the most part without venture at all; the VC-backed multi-billion-dollar winners in the vertical were among the few gaming bets seeded by generalists, which is partly what led to the evolution of gaming investment vehicles.
Five years ago we already saw the industry cross the $100B mark, and now we’re at $200B. Other than organic/inorganic growth inside of incumbents investing internal FTE/dollar resources, however, the only two routes prior to dedicated venture funding into games for building enterprise value as an independent developer were for the most part bootstrapping+organic, and securing milestone-based publishing financing, in which a team gave up a portion of future revenues in exchange for the capital to develop a game.
The multi-billion-dollar scale of acquisitions over the past decade, some of which were funded by generalist funds making bets at the outset of technology shifts in gaming, has led to the proliferation of gaming vehicles and billions of AUM set aside for investment into game developers. This in turn has institutionalized a third option: taking gaming venture dollars early to build a company & product foundation, which can open up many more potential routes to market if done successfully.
We see two scenarios that position gaming venture-backed companies for that optionality, upon which we’ll elaborate further through examples from the portfolio:
A. Company takes funding from gaming VC, builds a game, launches in soft and/or hard launch, and can pursue downstream funding from larger funds based on the strength of retention and monetization metrics (more common in mobile gaming);
B. Company takes funding from gaming VC, builds a go-to-market team, technology platform, and playable build that is strong enough to pass the high bar of strategic and/or publishing partners, who then put up the capital required to get the game to market with a “large budget” launch (more common for PC/console).
As mentioned in a previous post, the founders we back have either already had an exit or built a massive business inside a top gaming company previously. Typically this allows them to fund the initial 6-12 month development sprint themselves out of pocket with proceeds from that previous experience, so that by the time we lead the first institutional financing they already have the core team in place and a strong prototype build of the first game they want to bring to market. This was the case for both of the examples below.
The founders we’ll use as an example of Scenario A had played leadership roles in a company acquired by a large strategic, where they ran a division post-acquisition. They used the proceeds from that acquisition to get their mobile game ready for soft launch testing; we led the round to fund that push. They completed technical and scale testing in the Philippines, a common choice for doing so due to the low cost to acquire players, and then took the stable build to geographies like the commonwealth and Nordic countries to check retention and monetization. Those metrics met their target baselines, and they proceeded to worldwide launch. Over the course of the year they surpassed $3M in revenue, with healthy player retention and unit economics (initial cost to acquire players and average revenue per active player) and attracted additional downstream investors based on that performance.
The founder-CEO of the company we’ll use for Scenario B rose through the ranks to the executive team of one of today’s leading strategics, which went through multiple liquidity transactions. The CEO self-funded the first 9 months of operation, came to market with a team and graybox prototype for a cross-platform game, and we led the first institutional round. In under a year the company hired a full go-to-market team across disciplines, built a game that showcased cross-platform technology and gameplay, and went to market to select a partner for fully releasing and scaling a game. After playtesting with top VC and strategic investors, they selected to partner with a strategic who funded the entirety of remaining development, launch, and live service, with a built-in combination of geographic publishing.
In the former example, the company would not have been able to attract downstream capital without strong retention and monetization metrics; in the latter, the company would not have been able to secure a go-to-market financial and publishing partner without showcasing a game that surpassed the bar of top gameplay diligence teams. In today’s increasingly common lifecycle of securing gaming investor VC financing at the outset, and then release/scale capital from downstream venture and/or strategic investors, this is a matter of “do or die” for early stage gaming companies. Only the top echelon of teams is able to deliver the numbers and/or demonstrable quality cross that chasm, and options are limited if unable to do so. Teams’ options are limited to dissolution, acquihire (team pedigree must be very strong), co-development (developing a larger company’s game/IP in a work-for-hire construct), or accepting a traditional milestone-based publishing deal with an aggressive revenue share in favor of the publisher (likely with an IP other than theirs).
Allocators examining venture portfolios of gaming companies have limited exit data given that the gaming venture model is only a few years old- as mentioned previously, the largest exits to date in gaming have been organically funded, or received generalist venture financing- so evaluating the success of studios in “crossing the chasm” from initial institutional funding to securing downstream capital, and the terms at which such occurred (including valuation, revenue share, IP rights, etc.) is illustrative.