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Four Reasons Why VCs Won't Fund Game Companies

Traditional games companies can't get VC funding while a billion dollars poured into social and casual games in 2009. Why? Here's four reasons why VCs won't fund traditional games companies.

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

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