Esports Hyper-Growth Pt IV: Investors
This is a 4 part series:
Part I: Contenders vs Pretenders
Part II: Players
Part III: Staff
Part IV: Investors
Josh Chapman from Konvoy Ventures published a great article titled Esports Teams: Valued as Tech Companies and there’s also an article regarding a market correction in esports. In this article, I will share some insights regarding evaluating and investing into esports orgs.
Product-Market Fit
The term product-market fit will be used to put things into perspective and after co-founding an esports org, worked at T1 orgs and now on my current startup gamegether, inc., I’ve come to realize the importance of product-market fit. Many gaming and esports projects and companies have failed and more will fail because they didn’t achieve product-market fit. Product-market fit came from the analysis of the investing style of pioneer venture capitalist and Sequoia founder Don Valentine. It is a commonly used term in the startup world and is emphasized heavily at tech incubators like YC. It is surprisingly not mentioned much in the esports startup world.
Product-market fit is simply when you build something people want and love.
Investors usually bet on startups — like Discord — who have achieved product-market fit. So what is the “product” esports orgs are building? Community? Competitive? Media? Brand? Lifestyle? Some teams, it’s clear, but most teams, it’s a mix of everything or nothing.
Most teams don’t have a core differentiating product or compelling brand identity.
Before you continue, please read Part I: Contenders vs Pretenders where I talk about esports being in a hyper-growth market. Understanding that a hyper-growth market tends to prop up companies that haven’t figured out product market fit will help you more easily follow this article.
Vanity Metrics
I’ve seen many esports org decks and founders like to emphasize vanity metrics and little to nothing connecting it back to revenue growth or scaleable business model. Vanity metrics are things like Twitter followers and Facebook fans, etc.
Social metrics turn into “vanity” metrics when you use them to toot your own horn instead of connecting social activity back to real business objectives.
Metrics such as engagement rates, visits to conversion rate, and average revenue per customer are the ones that make a difference to a business.
So, this leads to a key question:
If the esports org’s “success” metrics are based mostly on vanity metrics that don’t connect back to revenue, do you think that their product will provide real value, monetize, and — most importantly — be built the right way?
Let me explain the differences between Tier 1 to Tier 3 orgs:
- T1 orgs measure themselves by actionable metrics that directly tie back to business results and customer success such as conversion rate, average revenue per customer, etc.
- T2 orgs measure themselves by social media engagement such as amplification rate, average engagement rate, etc.
- T3 orgs — majority of them — measure themselves by vanity metrics like follower count
So if an org isn’t focused on the right goals and metrics, it impacts the org from the top down:
- Actionable metrics focused orgs are building a core strategy around a great product or brand identity — that they can successfully monetize and scale. A great example is 100Thieves, they are the Supreme of esports — design, style, and cool — that’s their compelling value proposition as a media company. Their marketing drops sell out and they are backed by Sequoia, a legendary VC firm that makes bet on companies that have a great shot at becoming unicorns.
- Engagement focused orgs will have super fun, meme-y, and engaging social media that really amplifies the fandom and grows the fanbase. You can tell they’re great at it by looking at social media comments. Comments is important here — they reflect direct fan-to-brand engagement. Although they have great engagement, T2’s haven’t figured out a business model that they can monetize and scale. Not many orgs are T2 status because so many of them have low engagement metrics.
- Follower count focused orgs tend to do giveaways (paid acquisition) to increase their follower count “retweet and follow to get a chance to win X prize(s)” and post cookie-cutter tweets that get low engagement. They usually try to raise money from anyone and anywhere.
The plainly obvious thing is if you do #1, then you’ll probably get great organic results across #2 and #3 — that’s the power of product-market fit and focusing on the right metrics, if not you won’t successfully execute #1–3.
And #3 is similar to what tech startups without product-market fit do — lots of paid user acquisition and marketing to prop up their user base.
T3 orgs do the same with social media giveaways to prop up their follower metrics. Some social media giveaways are good such as celebrating a new partnership deal with a sponsor or rewarding followers with limited edition merch to celebrate something. You can spot giveaways by breaking down their follower graph history and look into large growth spikes happening in short bursts.
As an investor, these are 2 good questions:
Where does the org you are looking into fall on the tier list above?
How is the org acquiring followers/fans — how much of it is paid?
Press and Panels: what if the org was in press and/or panels! Appearing in articles or panels don’t really mean much, press doesn’t equal success. In fact, I would argue too many founders and executives are going to too many panels when their own companies haven’t figured out product-market fit. Panels are great for networking or spotting/recruiting key talent, however, you don’t have to go to too many of them.
Speaking on too many panels is a distraction and is nice for the ego — similar to vanity metrics — but not good for product-market fit if you don’t have it yet.
Once you do some due diligence, you will realize that many esports org don’t have product-market fit. Look into when the org posts a product (merchandise like clothing, shoes, etc.) for purchase and evaluate the engagement and you’ll see if they have product-market fit or not.
Esports grew organically from a deep connection and sense of passion, community, and fandom. Esports orgs who don’t viscerally understand this will find it super hard to get to product-market fit. Building a strong foundational business that resonates with your fanbase will always win over an artificial vanity-driven business.
Show me a publicly traded company that reports vanity metrics during quarterly calls…exactly, none do and that’s why they are publicly traded.
Another good question to ask is “What does your product/esports roadmap look like over the next few months/years and tell me about the metrics you are using to measure success?” This one question and how they answer will reveal if the esports org (the product) they are building is worth your investment.
I just spent that much time discussing vanity metrics, but that’s where esports is right now — fortunately it’s getting better as some start to figure things out.
Team, Problem, Product-Solution, Business Model
These are the 4 key things investors evaluate in a high-growth and attractive market like esports.
Team
Who they are and why they started the company? Look at authentic founders like Nadeshot of 100Thieves, LiQuiD112 of Team Liquid, TSMReginald of TSM or deep business acumen and esports experienced founders like Jack Etienne of Cloud9. If you dig into who they are and why they are doing what they are doing, you’ll usually find a deep and profound purpose behind them like Nadeshot’s story. Such founders usually have the vision, passion, and people skills to execute, innovate, and out-compete peers. They have a clear competitive advantage and have carved out unique brand identities which will give them a long-term path to effective monetization.
Turnover: Most solid orgs keep their talent, especially senior leaders, for more than a year and sometimes years. Orgs that have leadership problems turnover constantly due to lack of vision/strategy, bad people skills, poor culture/communication, etc. A savvy investor will do their due diligence here because it’s not a problem that’s easily identifiable from the outside. These same orgs will blame very high turnover on “growth” and how turnover is naturally part of every startup’s growth phases like moving from X to XX employees.
But it’s “growth” in hires, “growth” in burning more capital and not growth due to product-market fit — there is a big difference.
Esports is the most fun, passionate industry for many people working in it, so many have left traditional careers to pursue one in esports and never looked back. Turnover in esports inherently should be low, not high. Not many industries like manufacturing has the fun spirit of the esports industry.
Problem
Why is it a problem, how big is it? Should be billions of dollars addressable market. The biggest problem is when founders don’t clearly define an actual problem. The “problem” given is that esports is exploding in growth so you have to get in on it. Some orgs mention how the audience isn’t being reached effectively but stop there and don’t dig further into the pain points as to why.
A lack of understanding around what pain point you are solving and building for leads to no product-market fit.
This usually ties back to the founder not being an authentic founder and/or lacks business acumen — which is why they like to measure success by vanity metrics.
I grew up in Korea for 4 years (1999–2003) competing locally in Starcraft, and during that time modern esports was born — when Starcraft put esports on the map. And what I’ve noticed during my time in esports is that there are a lot of business-y people who are driven by money instead of purpose. Chasing money instead of purpose usually means they won’t be solving the right problem and won’t have the right vision — this usually leads to long-term ruin.
And the problem is so important, that is where it starts, where you build for your product-solution — it drives vision, right motivations, and usually gets you to product-market fit.
Product-market fit is important and I would add that founder-problem-market fit is just as important in nascent markets when you don’t 100% know what it will look like in the next 2-5 years.
Product-Solution
What are they building and how does it work? What’s special about it, unique insight, what’s the technology they developed that makes it so different ? It has to be a 10x difference, not a 1–2x.
What identity or brand are they building? Too many esports orgs pivot or let the community drive it for them. An esports org cannot become an enduring company or brand if they don’t drive their own identity in a very consistent and authentic way.
This might be a sign that they don’t have a CORE vision and may be flying blind. Identity is important because that’s how you can gain traction just like how TSM and FaZe have propelled their impressive fandom and OpTic, but then OpTic pivoted away from their core brand and declined.
How will the product or brand win? What’s special about it? Is there a unique insight? Like TSM being consistently ahead of the curve with trend-spotting— they were one of the first orgs to capitalize early on Fortnite while many other orgs lagged behind and some orgs didn’t even enter. They also interestingly were the first to launch a Fortnite Junior Squad.
Lastly, it has to be 10x difference not 1–2x and if you look at many esports orgs, they are similar cookies cut onto the same sheet. Winners are non-cookie cutters who build what people want and are able to virally grow their fandom. The beginning of FaZe’s unique Trickshots identity is a great example — they just went and created something people want and love with authentic founders driving it.
Business Model
How is this a business? Not surprisingly, this is the one that esports orgs struggle the most with when you compare it to their valuations — which are running at ~13x revenue.
Tech companies are valued at 10x revenue. But, what high growth and scalable business model have these esports org figured out that’s better than tech?
We don’t know yet because esports monetization is a huge challenge right now. And maybe that’s why org’s valuations are so high, because to investors, those orgs might have it figured out or they believe the founders will figure it out — we’ll see in the next 2 years because wherever eyeballs follow, money usually chases thereafter.
- Currently, investors are dealing with high burn with little to no scalable revenue to show for. Like modern day startups, the next step is “we’ll just raise the next round” and burn more without a clear ROI or huge revenue improvement from prior rounds.
- The revenue that is shown is static and not scalable, sponsorship revenue can help with org expenses, but shouldn’t get you a 13x valuation.
Sponsorship revenue in esports is usually 50%+ but for an esports org…can be 75%-90% of overall revenue! That’s untenable long-term because orgs are overly reliant on (1) an unscalable revenue source and (2) not 100% guaranteed revenues year after year. Compared to NBA teams, it’s around 15% because ticket to merchandise sales, etc. make up a bulk of NBA teams’ revenues.
- Streaming rights can be lucrative, but again, doesn’t justify 13x valuation.
- Prize pools are counted as org revenue which can dramatically affect an org’s valuation if they won major tournaments with huge multi-million dollar prize pools. Prize winnings aren’t predictably reoccurring revenue, it is unpredictable revenue where ~80% goes directly to the players making it lower margin.
As investors, look into how much of the revenue is from prize pool earnings. Because winning $5M in prize pool boosts the valuation by $65M if you use a 13x revenue valuation model. How much revenue is being derived from other sources, especially reoccurring ones?
- Fan/unit economics is everything — you have to figure out how to directly and indirectly monetize your fandom in scalable ways. Overly relying on publishers for revenue from leagues is not safe or stable long-term since publishers can dictate terms or shut down esports leagues when gaming trends change. However, what 100Thieves is doing with brand and merch can scale as we have seen Yeeyz and Supreme pull off.
The best esports orgs will have a scabable revenue model in place, overly relying on sponsorship and/or prize pool revenue is not a sustainable long-term strategy to scale revenue massively.
Impact of High Valuations
Too high valuations can actually become a problem. Even if a founder says “I will exert fiscal restraint” their board and/or investors will push them to make the capital get to work because “millions of dollars can’t just sit there —go deploy it productively!”
And due to such lofty expectations, companies tend to burn cash more rapidly than they should to satisfy investor urges, but without product-market fit the company is put in a very tough spot.
Reasonable valuations are better because it deters waste and doesn’t feed hype and ego as much but most importantly, it gifts the startup creative pressure. Over capitalized startups don’t face much creative pressure and as a result, don’t innovate as well. As Mark Suster puts it: “I think the creative pressure of not being over-capitalized actually helps with the innovation.”
Necessity is the mother of invention and if you are overly capitalized you won’t feel and operate in such a way that’s actually very good for a startup.
Summary
Hyper-growth is an experience that either kills your company or makes it much stronger.
Once the hyper growth esports tide subsides and a market correction comes, startups will have to hunker down and innovate or die — they have to achieve product-market fit. The #1 reason startups fail is because they don’t reach product-market fit.
Once hyper-growth markets reach a certain point, it begins to quickly sort out the winners from the losers and that point is starting to happen now.
The #2 reason startups fail is because they run out of cash and don’t have a long enough runway to continue multiple approaches and incarnations in pursuit of the ever elusive product-market fit and monetization. But the lucky few have or will figure it out I believe — they know where to go and how to get there.
Thank you for reading, if you have questions and/or want to connect, feel free to reach out to me on LinkedIn.
