Game Studio Funding: The Right Investor at the Right Stage

As a follow-up to our exploration of project-specific financing options in video games, we now turn to the world of company-based equity funding, where investors are betting on your ability to grow the value of your studio over the long term.

While publishers have been funding games since the dawn of the video game industry, more traditional business angel and venture capitalist (VC) communities are relatively new to the game industry’s investment table. Stories keep popping up about studios receiving millions of dollars in funds from VCs. And it sometimes amounts to a lot of money (for example, the recent US$1.25 billion investment into Epic Games)!

Photo: Fortnite

So, when game developers embark on their money-hunting quest, they often include VCs and angels on their hit list. But VCs and angels are critically part of a broader category of investors that fund companies. They do NOT invest in projects like publishers normally would. This means that company-level investors are taking equity in your studio (i.e., they are buying shares) and thereby become longer-term partners of your studio.

That being said, when you take on an equity investor, it does not mean you are relinquishing control over your company. While investors do gain certain rights and have voting power to the tune of the number of shares they hold, they are usually investing in the leadership and have no interest in taking over the company. Still, properly negotiating your shareholders’ agreement is one of the most important things you’ll do for the long-term health of your business.

Investing for growth

As a co-owner of your studio’s shares, equity investors care most about increasing the value of those shares over time. Yes, they want to back an inspiring founding team. Yes, they want to help you change the world. Yes, they want to see you succeed in creating something innovative and groundbreaking. But all of that is with the ultimate goal of generating a meaningful return on their investment, which only happens if they are able to sell the shares at a much higher price than what they initially paid for them.

Generally speaking, equity level investors want to back companies that have the potential to scale massively and deliver exponential growth. It is just the way their math works, when you consider that most investors build a portfolio of companies, and that most of those companies are likely to fail. Then the one or two that do succeed need to succeed to such an extent that they compensate for the others that failed.

It is critical to understand that if you are not working on projects that are massively scalable or situated within a business model capable of delivering exponential growth, then you are absolutely wasting your time talking to company-level investors. That does not necessarily mean that you can only do free-to-play / games-as-a-service games, although it’s most typical in today’s market.

Equity funding is no better than project funding and vice versa. They are simply different forms of funding best suited for different kinds of opportunities. Refer to the previous article on game project funding for more details on that aspect of fundraising.

Sources of equity funding

Now, assuming you do in fact have a scalable opportunity, here are the common sources of company-level funding:

Sweat Equity
You and your cofounders are always the first to invest in the company. Often not with actual cash, but through under/uncompensated time, effort, expertise, contacts, etc. (aka your blood, sweat and tears). This is also how cofounders generally earn their initial portion of company shares.

Friends, Family & Fools
This category is also often referred to as “love money” in that only someone who loves you would be foolish enough to invest in your company. There is a fine balance to maintain between your confidence in your success and risking the savings of loved ones, though later investors often interpret this as a positive signal.

Accelerators & Incubators
There are hundreds of accelerators and incubators across the globe offering to mentor your startup, provide entrepreneurial coaching, connect you to key partners and—ideally—also provide some funding. Sadly, very few of them will touch game studios, or have the right expertise/network to be relevant. So tread carefully.

Equity Crowdfunding
Less common than the normal “rewards” based crowdfunding platforms like Kickstarter and Indiegogo, equity crowdfunding offers an actual slice of your business. Since this is a means to solicit investments in highly risky endeavours, equity crowdfunding is heavily regulated and not necessarily legal in all countries.

Angels
Angels are wealthy individuals who are investing their personal money. Generally, they want to feel like they can provide more value/wisdom than just writing a cheque and therefore often invest in industries in which they already have had success (along with expertise, connections, etc. that they can share). Angels are often hard to find and usually do not “reveal” themselves or have a website. In some cases, they may belong to an angel network/group organized by city or region, which makes it slightly easier to find them. Alas, it often requires deep personal connections and non-stop hustling to find suitable angels.

Venture Capitalists (VCs)
VCs are professional investors and fund managers. Unlike angels who are investing their personal wealth, VCs are aggregating much larger investors (referred to as “limited partners” or “LPs”) into funds and then investing on their behalf. Many famous VC firms are located in Silicon Valley, but you can find VCs everywhere else around the globe. They are generally well-run firms that are staffed by professionals. They operate websites and often attend pitch and start-up events. The challenge for game developers is that many VCs tend not to invest in the game industry as they deem it too risky and are not familiar with the operational complexities of running a successful game studio.

Corporate Venture Funds
Also referred to as strategic investors, large corporations often manage an internal investment fund that allows them to invest in interesting/innovative companies that are relevant to their business. While making sound financial decisions remains critical, the priority of reaching a deal is more weighted toward potential strategic value. An example would be if Intel’s corporate venture fund invested in a start-up making advances in quantum computing. Many large publishers, especially those based in Asia, have taken an aggressive approach to strategic venture investing that goes beyond normal publishing deals.

Technically, an initial public offering (IPO) is also a form of selling your equity via a public stock market (e.g., the NASDAQ). But IPOs generally come much later after demonstrable success, and are beyond the scope of this article.

An important nuance to keep in mind is that not all equity investors are actually buying equity from the outset. Often, in the case of smaller or earlier investments, deals are done via a convertible note instrument. Essentially, this is a loan that is repaid in equity at maturity. It sounds more complicated than it actually is. The main benefit is that it allows you to accept early funding at a time when it is hard to place a tangible value/price on your shares.

Source relative to lifecycle

Now that we are familiar with the typical equity funding categories, we need to consider the ideal timing of each source in keeping with your company’s current stage. Sadly, we can’t just collect a big bag full of money whenever we want to. Understanding the sweet spot for each source is therefore critical.

The above graph follows a hypothetical game studio’s lifecycle, plotting its revenues over time along the blue line. At the start, the blue line goes negative given the studio is burning cash on development without generating any initial revenue. Then as the blue line heads upwards, revenues are coming in and the break-even line (i.e., the horizontal axis) is eventually crossed. That is when the studio begins to generate profits. This cycle’s timing is highly variable, depending on the size of the team, production scale, business model, platform, etc. That means it could all take place in a matter of weeks if you developed the next Flappy Bird-style success over the weekend. Or it could be a multiyear cycle if you are working on the next big MMO.

As you are getting started, love money is usually the only viable option. Love money consists of relatively small amounts of funds to help you get started and enable you to advance the project/business far enough to convince angels to invest. Angels rarely invest in ideas alone and demand something more tangible in exchange (e.g., a prototype or MVP or some other form of initial traction).

Angels are able to invest slightly larger amounts of money and—more importantly—provide wisdom to fuel your business progress. Ideally, they are also connected to seed VCs and can help with this stage of fundraising. With the progress made and traction gained with your angel money, then you can approach early-stage seed VCs for funding.

Importantly, these three categories of investors (FFFs, angels and seed VCs) are all coming in before you’ve proven that you can turn a profit. That means that they are taking bigger risks and are generally banking on the business’s vision and team’s pedigree. This is also the timeframe when incubators and accelerators come into play (i.e., pre-profit). While each program is highly variable, their sweet spot seems to be sometime between friends & family and angels.

Finally, once the company has proven it can generate consistent levels of profit, then normal VCs can be approached to fuel this initial success, with much larger growth-stage VCs arriving to fuel massive growth during phases of high profitability.

Now, despite all of those ‘typical’ scenarios, anything is possible when you benefit from certain unfair advantages (for example, your spouse just won the lottery or Fortnite’s creative director spins out to start a new studio). If that’s not you, then heed the typical timings outlined above.

A note on cheque size

Keep in mind that, as the amounts in funding increase at later stages (in some cases to the tune of tens or hundreds of millions), more has been proven/validated about the business. Later-stage investors writing bigger cheques are thus taking on less risk and uncertainty. In fact, it is your friends and family who initially wrote you small cheques for a few thousand dollars in a context of high uncertainty that actually took the biggest risks and are least likely to see a return on their investment.

Further, as a rule of thumb, the smaller the cheque, the ‘closer’ the investor is to you in terms of both relationship and geographical proximity. Friends and family potentially live under the same roof as you. Critically, angel investors prefer to invest where they live. First, they can be more involved, attend board meetings, go for coffee with the founders, test the prototype, etc. (without the cost/time burden of boarding a plane each time). Second, doing cross-border investing can become extremely costly (e.g., extra legal/tax advice, document translations, etc.) to the point of outpacing the actual amount invested. As deals approach the growth stages, the world opens up.

If you are still in the earlier pre-profit stages of your company, look ‘closer’ for investors. Be warned: jumping on a plane to fly across the globe to angel and VC hotbeds like Silicon Valley or Tel Aviv will most likely result in “nice, but come back when you are more advanced” style responses.

Closing the round

Fundraising for your company is rarely a one-shot deal. Few investors are willing to bankroll your entire budget based on an initial pitch. Fundraising is instead an ongoing (sometimes never ending) process of pitching, closing a round of funds and using those funds to gain traction/make progress. Then, that progress allows you to improve the story, and go back out and pitch/raise/progress all over again. Then come the profits…

In that sense, the rally race represents a good metaphor for fundraising: going from checkpoint to checkpoint, filling up with enough fuel and resources to survive until the next checkpoint, where fans and partners are waiting (hoping!) for you to arrive to fuel up again. All along, you’re checking the map and navigating around obstacles based on constantly updated conditions.

Luckily, we are not alone in this race and many have navigated it before us—though perhaps less so on the gaming soil. Still, there are countless resources, videos, events and blog posts from the start-up world to get you rolling. None are more suitable than Guy Kawasaki’s Art of the Start or Brad Feld’s Venture Deals.

See you all at the finish line!

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