Venture Capital & eSports

How to know if/when you should raise venture capital for your eSports venture.

I’m going to do two unconventional things: link venture capital to eSports and drop the VC focus on Silicon Valley (in an effort to help the rest of the world that is wondering).

TL;DR: Raise capital when you know how to make money and need money to make more money faster.

Venture Capital is not for every business. But it happens to be a great option for some eSports startups. This post is an attempt to clarify the uses of Venture Capital and in which cases it can be useful for eSports ventures.

In 2013, 843 startups attracted over $890M in seed venture funding.

While you may be startled at just how low the number of startups is (or perhaps the dollar amount surprised you), another even more important aspect is that a large majority of those deals were done in a small geographic cluster in California surnamed Silicon Valley.

Top tier investors reside where top tier companies lead nationwide technology innovation (often through the use of venture capital). But everywhere else, the raw amount of venture capital investors willing to invest at the seed stage (ideation / prototype phase — the most risky) is incredibly low.

If you pair this with the fact that investors only invest in about 1% of the deals they see and that most current investors don’t understand the business of eSports (because there isn’t one), it becomes clear that new eSports startups are faced with a difficult challenge.

To understand if VC funding is appropriate for your business, you must understand how it works. Many people confuse VCs for angels (wealthy individuals who invest on a personal basis). Many VCs happen to be angels, but their profession is to invest at an institutional level.

LPs’ money goes into VC Fund. The VC Fund invests the LPs’ money into several companies, hoping to generate large returns outweighing the investments.

The same way your startup is trying to raise funds to make money through the creation and monetization of your product, VCs raise funds from other investors (LPs—or Limited Partners) to make money by investing in successful startups.

The dynamics of venture capital are too complicated for a single post, so I’m going to list a couple of pointers that should enable a basic understanding of how they work:

VCs stick to markets they understand.

As investments in their domain begin to yield successes, VCs slowly begin to inch into other verticals and start experimenting. It is very rare for a VC to make a bet (because that’s what it is if they don’t understand the market) by investing outside of their comfort zone. The reason for this is simple: they’re not investing with their money. They’re investing LP money.

This makes it really hard for us eSports folks because—well, most investors don’t get it because this is a new industry and there aren’t any wealthy people who understand eSports. And that’s the case because eSports hasn’t made anybody wealthy yet!

Your business must go public or be sold for the VC to make his money.

Venture Capital is not a good option for service businesses because they seldom get purchased by competitors. Some service businesses do sell, but not at a level that will impact the success of a VC fund—and they are not interested in a dividend-based holding strategy.

However, venture capital is great for technology-oriented (like Web) startups. They are quick to grow, are purchased by competitors, and often command a sizeable return for their defensible technology. If a VC invests in you, they believe in you enough that they believe you will deliver a 10x return on their investment.

You will lose an increasing amount of control over your company

As time moves forward and as you keep raising additional rounds (to sustain growth), the shares you own in your company will slowly dilute (as you sell chunks of the business to investors).

I won’t get into the nitty-gritty of whether it is worth it for the entrepreneur, but a talented founder will learn over time how much to raise and when—and most importantly, at what valuation.

VCs are business partners

VCs are partners in your company. Their value is demonstrated through the generation of tangible value for the startup other than the cash investment. Strategic investors are the right investors because they can add a layer of value on top of their investment. And you only get that with an investor who gets your idea and shares expertise in your field. Which is a luxury we do not have in electronic sports.

Twitch enjoyed great momentum because it was able to ride the tech startup wave in the Valley—it just happened to have gaming founders. This gave it access to top-tier venture funds—and that comes with an incredibly powerful network that is more valuable than the money by an order of magnitude.

Here’s my money. I hope to see it back within 3-5 years, grown by 10x.
You have to give your investors their money back

When you sell your company, everyone who owns shares get paid based on the percentage they own and the purchase price. If I own 20% of a business being sold at $10M, I should get $2M right? It depends. Each additional round you raise places an additional investor in-front of you in line to get paid in an M&A event (such as an acquisition). If you happen to raise too much, it’s possible you will walk away with nothing after years of work.

They will sit on your board

A seed investment typically comes with a requirement for the lead investor to sit on the board. It isn’t rare for each additional lead investor in subsequent rounds to make the same requirement. This can be a good thing as it can be a bad thing. A VC on a board is fully vested and engaged. But if there is a lack of execution or synergy, things can go south real fast.

VC money is meant to be gasoline on a revenue fire.

When a company raises a round, it’s because it recently found a new way to make money profitably and needs more money to do it faster—there is no other reason. How much you should raise depends on your stage and how long you need to get to your next milestone.

There are three main stages to funding a company. Here’s a flyover:

  • A startup at the ideation phase should raise <$100K to prove their concept — this capital is referred to as pre-seed funding. It usually comes from a couple of angels who believe in the vision (as there is no product to show). A lot of accelerators are using this model by funding multiple companies at a time (in cohorts). The danger of raising over this amount is obvious: complacency, lack of focus, mellow budgeting, blah. Raise what you need to build a minimum viable product and prove your concept.
  • A validated startup with proven traction can then raise a seed round, typically <$1M for web-oriented startups. You’re wondering, “woah, that’s a lot of money”. Yes, but that money is going into a proven system. The seed round’s purpose is to get to product/market-fit. I referenced it briefly in my last post.
  • Once the startup knows its customer, the value it creates, how it delivers this value (probably badly due to staying lean on funds) and how it will monetize, it raises a Series A round. This round typically ranges from $1M-$10M depending on the vertical and a bunch of other things. If you just found the cure for cancer and need to increase your production capacity to infinite, the Series A will be much higher. You get the point.
  • Once the company goes to revenue and ideally achieves profitability, it can choose to raise another round, this time a Series B (then C, D, and so on). Additional rounds are driver rounds. The gist remains the same: we know how to make money, we just need more cash flow to make it faster. But the company may be generating enough through revenue that it doesn’t need to raise more funds. That is an awesome situation to be in and is win-win for current investors and entrepreneurs alike.
  • The exit is the event during which the company is either purchased, merged with another company or goes public. In all of these events, the founding team and investors’ shares are cashed out (based on the percentage each owns and the purchase price). This is when the investor and founders are paid. When you accept a pre-seed investment, you commit to doing everything in your power to making this event a reality.

That’s a long breakdown! The point here is to realize just how long you commit to spending with the VC as a quintessential partner in executing the vision of the company, and that VC money is strategic money.

What this means for eSports

Until the first generation of eSports entrepreneurs experience their first exits (MLG, ESL, Twitch or eSports team acquisitions) it is unlikely that eSports will develop a healthy startup ecosystem.

But since the main heavy-hitters also happen to be first-movers—and I don’t see Turtle Entertainment’s Electronic Sports League ever going public or being acquired; it is the perfect example of a service business—the only likely success will be that those behemoths will start purchasing companies. When it comes to who will buy who, It’s all really fuzzy. And that’s a really bad thing for everyone.

I find great comfort in knowing that the nature of this industry dictates that every year, there are winners of multiple hundreds of thousands of dollars by way of cash prizing. But the success of our industry is dependent on a natural cycle of startups being funded and purchased by eSports (or other) companies. Or if technology VCs educate on eSports over time, that too could be a game-changer. Until one of these scenarios happens, monopoly will remain.

Whether eSports players will eventually become active eSports angels investing in eSports startups when they retire is an enigma to me. If this were to happen, eSports would finally gain access to the financial and mentorship backing it lacks to sustain itself from the bottom up.

If an eSports startup is seriously considering VC funding, it must comply with the basic dynamics of the game and acknowledge what VCs look for. eSports teams are an outrageously risky investment and will be ignored unless a prodigy player appears—and even then, there wouldn’t be anyone with money in eSports to finance that prodigy unless they were discovered, scouted, recruited and financed by a top team.

If you plan to make a career in eSports as an entrepreneur, my advice is to assess whether venture capital is even necessary to grow your business.

Blogs, news sites and eSports teams all follow pre-existing models and should strive to achieve excellence in their own domains and monetize creatively.

The best case scenario is to take money from no-one.

VC-fundable startups will be the ones that will offer investors a clear path to create a large exit (for the VC, an acquisition or an IPO is always the most desirable result). eSports is already a big market, and there’s tons of space to innovate on top of what exists.

Your eSports startup doesn’t have to be an eSports team!

Like I said last time, today’s big eSports companies were all startups and all grew large by using VC capital — but they are companies that push the boundaries of today’s eSports and are leaders within their own sub-categories who required this capital to see their visions through. They think big and attracted the big money needed to execute big.

An eSports team will never grow the size of Twitch, Riot Games or MLG. The best thing to do is to try to live in the future and to find what’s missing.

Special thanks to Matt Allan, Drekken Pownz and Hugo Twaalfhoven for editing and proof-reading.