A Pair of Venture Capital Lessons Learned from Lottery Tickets
Recently I’ve been evaluating a company that wants to work with states to bring lottery products — mega millions, Powerballs, and quick picks — to mobile.
Their product works, is meaningfully better than buying a lottery ticket at your corner convenience store, and could generate more revenue for the state than the analog alternative. Features like office pools expand functionality for consumers and analytics could allow state agencies to ensure people are gambling responsibly. The team has hustle and technical chops that have allowed it to launch, legally, without the blessing of the state. Lotteries are a $160 billion dollar industry, but despite the giant pot, strong product, and impressive team, investing in startups built on gambling feels like a bit like a roll of the dice.
Logically, this deal ticks all the boxes on the diligence checklist, but when it comes to gambling, very few people remain rational. The success of this company will hinge less on how well the team executes and more on whether future investors and state regulators want to ante up, or fold on the future.
It’s Hard to Account for Irrationality
Gambling has been a touchy area for VC investment in the past. Like other adult businesses, VCs are concerned about the viability of these companies earning follow-on funding or finding acquirers. Adult websites can generate prodigious cash flows, but there are few eager buyers. Some VCs are actually barred from investing in certain kinds of businesses due to morals clauses. One would think building on top of a lottery platform established by the state is different than investing in online gambling tech, but it’s a tossup.
Often, the decision to invest comes down to how an opportunity is branded. Most VCs would instantly pass on a lottery-based startup, but DraftKings has raised $75MM, and their value proposition lures new players in with the promise of immense cash payouts. DraftKings is technically a game of skill, but is it really that much different than betting at a sports book? Positioning and early traction can make all the difference.
Bet Carefully on Deals Flush with Regulatory Risk
Each state has its own lottery commission that can shut down a fledgling startup and this adds risk to any potential deal.
Note: I am not suggesting that we move to free-markets with gambling. I know there are people out there that cannot gamble responsibly and hence we need a neutral third-party to keep things in check. But we cannot use responsible gambling as an excuse to prevent innovative companies from disrupting the incumbents.
Lobbying by bodegas, convenience stores, and gas station owners could create pushback with regulators. Risk aversion and technical incompetence could lead lottery commissioners to maintain status quo at the cost of technical advancement, or cause them to award contracts to larger, local tech firms.
Still, in some ways, it’s actually safer to bet on the lottery versus medical devices or drones. Not only is the market larger, but The FDA and FAA operate at the national level and serve as a single point of failure for startups. State-level lottery boards give entrepreneurs the benefit of 50 regulatory markets to sell into and win over piecemeal.
Governments are slow moving entities. Change takes time. But I am hopeful that one day rational decisions will be made at all levels of government. In the meantime, investors must account for irrational actors in the value chain and learn when to hold them, when to fold them, when to walk away, and when to run.
