9 lessons for understanding gaming investors + Q/A

Photo by Volodymyr Hryshchenko on Unsplash

I did a presentation for Elite Game Developers community in February 2020. Here are the notes and the Q&A from that presentation.

There’s a lot of things I’ve seen. I’ve been in discussion with investors for the last 15 years. I’ve been learning about what they like, and what is their profession? I think that’s the key here: It’s to understand what investors are? Why are they in the business of doing venture capital? Why are people investing money into startups?

There are different investor motivations that I want to cover. To point out a few things. I wanted to go into these nine topics that I wanted to cover here.

1. When should you start raising funding for a games company?

I would say that never start raising until you can justify $1 million pre-money valuation, meaning that your company is when you’re pitching to investors, you can justify that the worth of the company is at least $1 million. Otherwise, you’re going to be ending up giving out too much for too little This is this has happened I’ve seen this happen so many times when people are raising, you know, 50k here, 50k there, 100k here. They end up like giving out chunks of their company too often. What ends up happening is that they can’t justify a high enough valuation when they still don’t have something to prove. So let’s take this kind of example here that you have a monthly burn of 15,000 US dollars, which is not a lot, it’s something that will mean that you’re going to be struggling with your cash flow.

Regarding your own cash flow: how big of a salary do you need? Maybe you have an apartment, and you’re paying a bank loan on your home. These kinds of situations can be quite tricky. But what I’ve seen is that if you go to 15k that can last you for a long time. And then you can start counting that you can get to 18 months with 270K.

So here you can see a calculation of where we could be at with a 1 million pre-money valuation. If you raise 270k, the investor gets close to 21%, which is the right spot for any early-stage company, when you don’t have a track record, when you don’t have enough traction. 21% dilution is something I would aim for if I would be in the situation of building my first games company now.

2. The first money that you’re bringing into the company, I would start with this kind of operator angels as the first money.

What is an operator angel? These are people who, who get to pay you to work for you. So in a sense, there are people who want to start doing a lot of different kinds of tasks at the early stage of the company. You’re building a company with them, and you can leverage their network, their peer network, to source new hires. If you’re missing a marketing person, they can start finding the marketing person; then, they can do interviews and onboard these new hires. So I’ve been a little bit doing this with a few companies here in Finland, it is very time-consuming for me because I’m also building my own company (Elite Game Developers). So in a sense, if you find these full-time angels who have this operational experience from gaming, that’s a significant benefit. You’re getting money, but you’re also gaining experience and time from people who know what they’re doing.

3. What is the difference between an angel and a VC?

The main difference is that the angels most often are investing their own money, which they’ve gotten from whatever business or work they had. Maybe they sold their company, perhaps there’s sold some shares, whatever, but they’re working in the sector, they’re going back into company building phases with other entrepreneurs. So there are people like this who want to help and work for you as well. VC will do all of this as well. The difference here is that the VC has built a fund of money from other people. So they’re investing other people’s money, and it makes it a bit different for them for operating.


4. VCs look for the Goldilocks zone, compared to angels who are more elusive on where they invest

So the VCs are looking for the just-right opportunity. The right risk levels, so that there’s not too much risk, but there’s a big opportunity. Here are the Goldilocks zone criteria that a lot of gaming VCs in Europe tend to look at:

A) They want to look at the team that has a proven track record. They’ve been building games in a bigger company for many years, successfully seeing what that’s like, seeing the growth of a company.

B) Then you have a team that comes in with a blue ocean story of, “Hey, this is what I want to do. This is an opportunity that we’re going after. It’s not too crowded there.” The blue ocean is also something that in the Goldilocks zone. The VCs want to see that it’s not too crowded.

C) For sure, you have the repeat founders, who are also looking at, like, how are we going to back these repeat founders who are coming back to building another games company. I was in this situation when we were starting Next Games. I already had a career in building a games company and raising money from investors. I was at Supercell for a while. I was definitely in that Goldilocks zone with Next Games.

This Goldilock zone matters; it’s continuously coming up in deals. So you need to understand that it’s not an unfairness in the market. It’s just the way it is. There are better startups for the VCs to put their bets in.

5. Privilege founders. Why someone gets 10 million without any numbers?

The founders left a big company that was building the most significant game ever. And now you’re doing your own thing. And of course, the repeat founders fall into similar criteria. This is where all the VCs want in. These cases come up only once or twice a year. A dream team has left a bigger game company to start their own thing.

6. Which investors should you be pitching?

Only talk with people who understand gaming. Of course, you’re narrowing your target audience to a tiny segment of investors. Let’s say there’s like hundreds of VCs out there. But how many of them know what gaming is? Probably only a few. In the early stage, talking only to gaming VCs can be tough. There are these early-stage VCs who have made one or two gaming investments, but do they know gaming? I would say, not necessarily. They might say that “We did this gaming investment when we had this partner who already left the firm” or something like this.

If you raise from investors without the gaming knowledge, you should be warier about what kind of help you’re going to get from these investors. So there’s, there’s A list, you got your LVP, you got your Play Ventures and others. So definitely those people can help out a lot.

When you go to them, and they say no to you. What does that mean? You could think about it as a point that, you got a NO, but what does the NO mean? Is it more like, never NO, or is it more like, “Hey, let’s meet back in four months and see what kind of progress you’ve made.”

What you could also do is think about, am I going approach an A list game investor right now? Or should I get more evidence and proof that I have a compelling company in my hands?

Then you have the B list. These are investors who’ve made a couple of investments into gaming, but they don’t have a partner who’s worked in gaming. And that’s usually a problem. They can’t contribute to discussions on what needs to be done with the company next, regarding your products and distribution, etc.

And then you have your C list. These are the investors who cause more problems when they come on board. Some investors want more control and want a more significant stake than the rest of the investors.

How do you spot the A, B, and C investors? The main thing that you ask for references. Speak to everyone who has worked with these investors before and ask about the partners.

a) What they’re like,
b) how they operate when invested in the company, or when they are on your board of directors.

Invest a significant amount of time on this.  I often hear a founder talking to certain investors that I know who are known troublemakers. There are kinds of investors who come into the company, and they start changing things. And they want to spend a lot of time with the founder to talk about their agenda and discuss irrelevant topics.

Ask the VCs for intros to the successful founders, and the unsuccessful founders as well that they’ve invested in. So like if you have a VC, you don’t know them well, but they seem like outstanding investors. Ask for intros to their founders that are already in their portfolio.

7. When when you start meeting with investors, start working on your storytelling.

So the pitch is all about a story:
a) you have a compelling story, and
b) you have a convincing plan of execution
Investors don’t often want to overthink when evaluating cases. So keep them happy by telling a great story, something that they don’t hear every day and that will open their eyes and make you appealing to them.

8. Ownership requirement.

Some of the investors, especially on the VC side, are happy with the minority of 5% to 15%. When you’re talking to angels, you should think about this range and go back to thinking about the 1 million pre-money. If you have an angel who’s ready to put in 75K, and they want 50% of the company, leave immediately. Always think: “hey, do we want this person on board? What are they happy with? What is their range of investments usually?” But there are cases where people do want 20%, but they’re willing to put up enough money to achieve the 20% ownership.

Let’s explain some of the venture capital mathematics here:

Usually, the VCs has a portfolio of companies, let’s say 50 to 70 different companies that the VC has invested in. One-third of those companies will just evaporate, lose all their money; they won’t go anywhere. Nobody wants to fund them, so they go bust. And then you have another one third, who are going to return the cash to the VCs to the fund. If they invested 1 million, and the company is sold for a low price where the VC gets 1 million back. But then one third will go up to 4x to 10x returns, which means that there will be a pretty good amount of money coming back to the fund. But usually what happens with this 50 to 70 companies in the portfolio is that one of those companies will return the whole fund. 4x or higher is the optimal case for the VCs. And also an average for a professional VC who is investing well enough.

But what does this mean for you? The question is the 20% dilution. Figure out if this VC wants a 3x return in three years, or 100x return in 10 years, ask if they want a quick exit? Or are they saying that “Hey, we’re building a company with you that can last for generations.” And in 10 years, there’s probably going to be an IPO. Maybe there’s going to be a secondary sale of shares. The investor is going to be getting their money back, like in an Uber or a Supercell. You should be looking at the VC’s motivation, which then goes into how they advise you as a founder on building the company. And mostly VCs optimize for the former. They’re going for 200x return. They understand that short term gains are going to be harder to optimize for, rather than building a good foundation that lasts for decades.

9. What do you want from the investor? Are you only getting money?

Figure out ways that the investor can add value, usually, like we were talking about the operator angels. If they can recruit team members for your company, that’s going to be an excellent benefit for you. And then advising on product and marketing. If they’ve been in gaming, they would know the different moments where they bumped into issues regarding product development, people, marketing, growth, how to use funds, how to do hiring for growing, etc. And of course, like helping out in the next funding round, building an even better story, going back to the storytelling bit.

Q&A

Q: How do you evaluate your game dev company, so that you have a credible number?

A: Think about this 1 million pre-money. It’s credible if you have the right team in place — the right pedigree in the team, and a compelling story. The structure could be: this is what we’re doing, this is the product, this is what we’re going to be doing the first 12 months. Then you continue to talk about the market and how you know enough about the market.
There’s a lot of these kinds of details that you can start thinking about: What goes into a business. How are you approaching your business? If you lack certain things, that you’re going to need down the line, start having at least plans for getting these things in place. Then you can credibly justify a $1 million pre-money valuation.

Q: If you are a new startup or team that is looking to start a gaming company, what sort of funding range should you aim for? You said that you should aim for 1 million valuation. But is that realistic?

A: Let’s say a team of five people who’ve worked together for five years, but not in the game industry. If you lack experience in the games industry, does it hurt? I was talking about this experience thing with another angel investor just recently. He was pointing out that if you have entrepreneurial background coming for outside of gaming, to gaming, and if you have specific experience that you can bring into gaming and start learning the gaming industry quickly, I think it is realistic to raise. Then it goes into looking at other skills you have. Maybe you have superb technical skills. Are you thinking about bringing in people who are knowledgeable about the game industry? I think that really like goes into like, justifying a $1 million pre-money.

Q: Can you explain Series A, B, and C?

A: Series A is the point where you’re raising a round, and where different kind of conditions come into play regarding a shareholders agreement, where the new investors want board seats, they want preferred shares.
Preferred shares: when the company is sold, the investors in the Series A, B, and C will get their money first, before the leftover money goes to the founders and the employees. There are different kinds of restrictions that come into play. Of course, you’re raising a bit bigger amount of money. So there needs to be more kind of like this caretaking for the investors that they have some control over the company. But at that stage, you need to know that you’re pushing into the same direction that you have alignment with these investors if you’re restricting yourself with the shareholder’s agreement.

Q: What would a standard way of getting payments from an investor look like?

A: It’s usually a wire transfer once all the paperwork has been completed.

Q: How to justify value if you don’t have cash flow yet?

A: This goes into the team and to the story. What market you’re tackling, and what is your execution plan. So I think that that will justify value.

Q: How does one plan pivoting as you did with your first startup?

A: That’s an excellent question. The pivot from virtual worlds to Facebook Canvas games came from our investors. I was blindfolded. I was looking like, “Hey, we need to get this product to work. We’ve been working on it for four years. We can’t quit now. We still have a lot of things to explore with the virtual world.” But we were not growing. We had a few thousand euros of revenue per month with that product. And it had flatlined for ages. So it was a wake-up call from the investors actually to look at the pivot. So they were pleased that we did it. So those discussions with your investors are something you shouldn’t be afraid about. Ask them always if there should be more significant changes happening in the company. Push your investors for feedback.

Q: How do you raise when you don’t have any products?

A: I think I covered this a bit here. It’s the opportunity, the story, the execution plan, think about these components. And your team. Is it a team that could execute the plan.

Q: What are the things an investor will be paying attention to when he or she hears of a startup looking for new funding?

A: I think it’s always about this kind of like uniqueness, that there’s something that differentiates you, your company from the rest. Especially the very knowledgeable gaming investors will say NO to something that sounds like a me-too kind of approach. If you have a compelling story and an effective execution plan, you’re going to look already different there. So to differentiate is an important point there.

Q: In your opinion, which would an investor most likely value more, a) real traction by a newbie team, or b) an expert team with no traction yet?

A: Often, it’s the expert team, unfortunately, but it also depends on the newbie team’s traction. If there’s profitability already there? If there’s a product that is growing, then the newbie team is something that the investor will think about, “Hey, if I join these people, I will be happy to put some of my own time to help these guys grow as people and to learn.” But if you’re very early with real traction, maybe you have great retention numbers, but no monetization yet? It depends on the details.

Q: What does an investor want to know about a company seeking finances?

A: It’s the story. It is that and the team. Those are the main things. So go after an attractive market that you know that you can be the best people to execute on that market. There are a lot of questions that the VC will look at.

Q: What do you think of the preferred shares? Are they worth more then they are in trouble, considering raising money and attracting investors?

A: I think it’s a de-facto of the industry that when you raise a Series A or even a priced Seed round, you will have these preferred shares. And I think it’s no way to go around. Of course, if you don’t want to raise money at that stage, maybe you want to raise it when you don’t need it. Then you can point out your own terms to the investors. If you have a hit game, you can justify your own terms for the investors. I think Rovio did that when they raised after the Angry Birds success. They didn’t give out any control to the investors who invested in their bigger round before the IPO.

Q: Can you raise when you don’t have any products?

A: You have to have an idea of a product, at least. This is something that you need. If you just have a team, and you’re figuring out things like “What we’re going to do? we’re going to raise money, and then we figure out.” I don’t think that’s going to work. But if you don’t have a product live, yes, you can raise, if you have an outstanding story.

Q: Can I build a startup by starting a service business unit and product development units simultaneously, to focus on our own product gradually?

A: I think that’s a bit of a difficult point to sell to investors that you’re building a service business where you’re going to be an outsourcing outfit for other companies, and then you’re building your own games. Your focus should be on your own products when a VC comes in because that’s where they’re going to be putting their money into. But there are different kinds of cases. If you have a service business, which is already bringing in millions annually, you can justify another kind of route. But it’s not that easy usually when you’re just starting off, and you’re saying that we’re going to have two units. One is going to do services. One is going to build our own products. It’s a mixed bag for investors.

Q: Is it reasonable to entertain strategic investors like a bigger gaming company for the early stage?

A: What we did at Next Games was that we raised money from AMC, who was the licensor for The Walking Dead. I think there are benefits for sure for strategics. There are different alignments regarding the strategic’s appetite. VCs are more aligned with returning their funds. But if you have a strategic, they might have a strategic opportunity for their products, if they align with your company. But in a few years, things could be changing, and then you might be in a situation where you’re not aligned at all with the goals. So why did the strategic invest in the first place? They don’t have time for you anymore — things like that. So I think this is the biggest problem with strategics.

Q: What does an investor want to know about the company seeking finances in the first contact and the second contact?

A: This is something I cover in the course. How to message with investors? How you approach them, etc. They want to hear the story. Send something minimal, not a pitch deck with 30 slides. That storytelling bit is something you need to start working on immediately, before even talking to investors. You can, of course, practice your communications with investors by meeting up with that you don’t 100% consider as somebody who you’d want to raise from, or maybe you’d want to, but they’re super friendly, and you can get like feedback on the story. Use them for exercising your pitch.

Q: How and where would you advise to find gaming angel investors if you don’t have a network?

A:  I was contemplating on building an angel network here in Finland and in the Nordics. I went and met with the dozen angels who’ve invested in gaming. But the problem is that they’re all in different situations. Some are broke angels; they don’t have money to invest at the moment. Some don’t want to invest in gaming anymore because they don’t have time to figure out the games industry. It is tricky. That’s something that needs to be fixed, and I will let you know when I have a better answer for this. I’m still working on figuring out how to fix the situation by finding gaming angels.

Q: How much does work for hire count for towards pedigree of the team compared to own titles?

A: I think it does count. If you’ve been working on projects for clients, that’s fine. Work for hires is fine. The difference here is that if you worked in a games company, you’ve seen the dynamics of what it’s like to grow a games company, versus just working as a consultant or work-for-hire where you don’t go into analyzing the cultures and living the company culture. So that is the main difference there.

Q: Do you have an example of a good game companies story?

A: There’s a lot of good ones for sure. Thinking about Supercell’s story. The founders had founded a company called Sumea earlier, which then became Digital Chocolate in a merger. And then afterward, trying to build that company for ten years and not getting to where they wanted, they left and started Supercell. So that is a perfect story there where you’ve already built something. Most of the excellent game company stories come from repeat founders who already built companies before. There are a few exceptions like Fingersoft here and in Finland, who created Hill Climb Racing. It was a single founder who was doing a lot of mobile apps. And then he developed a few games. Hill Climb Racing was his biggest hit. The reason for the success was that he already had an app portfolio. So he had a camera application that was getting millions of installs on Android, and he started cross-promoting Hill Climb Racing through that camera app. And it took off from there, and he didn’t have any significant gaming company experiences before Fingersoft.

Q: Do you have tips on selling a remote team to investors?

A: I don’t think it’s a big issue nowadays. I think it’s more about like, the questions there will be from the investors is how do you build a culture? Do you already have a plan to tackle specific cultural issues that might come up with people not sitting in the same room, but they’re more or less virtually meeting each other on Slack, etc. There are good examples from Silicon Valley, where all of the companies are now building remote organizations. You can look at the tips and tricks from there and incorporate them into your story.

Q: What is your opinion on funding advisors who charge a success fee based on funds raised for organizing and managing a funding process?

A: Advisors are quite tricky, especially with the success fee that’s tied into the amount they raise. I think there are good options here. With these kinds of situations, you should ask for references to these advisors from people who worked with them before. Do they have connections in the games industry? Can they help with the pitch, specifically with the pitch? I think this is the key here. Of course, they can do intros, but the VC and the investor will want to meet the founders and chat with the founders on how the company will be built. They’re not going to be talking with the advisor on how this company is going to be built? The advisor will only be helping you for a short time. And it’s mostly going to go into the founder’s storytelling part of raising a successful round.

Q: You mentioned the investment would wire transfer the money to the company. But would we all at once or in the norm that is gated behind milestones?

A: Usually, there aren’t required milestones for VC or angel investments. All the money is sent immediately. I’ve heard of VCs who are operating in this model, but that’s not the norm at all. The problem with this model would be that the founders can’t guarantee that they have the money in the bank if they need to grow faster. So you should always ask the VCs if they are going to hand over the money immediately when the round happens, or will there be trenches?

Q: What is your opinion on using convertible notes versus a priced round?

A: I think the best thing about the convertible notes is that it’s speedy to do the paperwork where it’s debt money coming into the company, versus doing a price round where you’re creating new shares in the company for the investor. With the note, you’re postponing the actual pricing round where the investor becomes an owner. We cover the convertible notes and the price rounds in much detail in the course.

Q: Do you need a vertical full vertical slice of the game to get an investor’s money.

A: No, but you get a lot of bonus points for having a good demo of a game. Usually, it’s not necessary. If you have the core gameplay, it should be fine. But it depends on what is the product that you’re creating? Like, what is the market that you’re going after? Like, how can you explain what you’re doing? If your whole pitch is about one game, then it helps to have a running prototype demo of the game. And to the extent of how big it should be. It depends on what you’re selling. If you’re selling beautiful technology, you want to show that you can build that technology. But mostly it’s about some kind of prototype already.

Q: Once I have my company funded, what are the best sources for team members, technology and marketing, different services?

A: You should look at your own network, your investor’s network, for hiring people. That’s the best way to source and the local tech community if you’re living close to one. I’m covering this well in my book, the “Long Term Game.”

Q: if you already have some runway, does it make sense to postpone fundraising to a later stage?

A: The further you go without raising the better. It’s a positive problem down the road. You can create a better story. You’re refining your details there. But you could be meeting up with the VCs already. Inform them that “we’re just doing this and that at the moment. We’re not raising yet, but I wanted to hear your feedback. Maybe we can work together in the future.”
Not needing to raise quickly is a situation that every founder should aim for. If you can work part-time on your startup before you jump into it full time, that’s super helpful. And then meet up with the VCs and create a relationship with them. And then maybe 12 months later you start raising the funding.

Q: What investors are looking for in a team with no experience?

A: It’s difficult to say one answer to this. There’s a lot of things that they will look at: How quick are you at learning? What do you need to learn in the business? Are you that person who’s going to be picking up all the skills that they need? And then there’s a lot of different things regarding what you want to achieve. And the team aspects: if the team has specific backgrounds? If you have no experience in anything, that’s going to be tricky. But if you have some experience, how can you bring some value from that, into building the company?

Q: How do you find gaming partners to team up with if you’re not in the gaming field.

A: My book “Long Term Game” actually covers this as well nicely so you can check it out there. Usually, it’s being close to like a tech hub living in a tech hub, meeting people in meetups, there’s a lot of websites that advertise meetups in these bigger cities. So where you can meet up people in the startup scene, so maybe you can meet the people who you want to partner with to build a company with.

Q: Can VC help with managing the funds for you?

A: Yeah, for sure. That’s something you should ask them. You can ask, “Here’s my plan. What do you think works with this plan, and what doesn’t work?” Of course, you’re selling the company to the VC; you’re pitching it. But it is a good pointer that if you show that you can be a person who is interested in hearing what the VC thinks about your plan. That’s always an excellent point, like a bonus point from the VC that if you open up your plan to be changed, that you’re not afraid about changing everything in your plan.

Q: Do I need to see CFO or payroll after raising?

A: I think there’s a lot of services out there who can help you out with financial stuff. I recently wrote a blog post on cash flow. You could check out that post for this question.

Q: Do investors generally prefer companies with one solid game concept or a company with a bunch of concepts they can go out to test with?

A: I would say one concept is great. But I would back off one step from here and think about what is your product strategy? What is the mission of the company? What is the area you want to operate in? I’ve seen a lot of pitches in the mid-core space, where there’s one game concept idea that the startup is going after. That usually means that the company will be putting focus into one game for 12 to 18 months before they know for sure that it’s going to be a hit or miss. It depends on the game. If you’re going after a more casual audience, then it makes sense to have a product strategy angle or understanding of the genre that you’re going after.

Q: Is it a good option to look at incubators like Y Combinator during bootstrapping mode? What is the usual equity giveaway for the support received to take off?

A: I think there are two questions here. So incubators in gaming, there aren’t any good ones that help with gaming specifically. So if you go to Y Combinator, they are a lot more helpful when you’re dealing with business to business startups. They’re good at that because they have a network of current and alumni YC companies who sell to each other. That’s the big benefit of Y Combinator. Such different accelerators like TechStars in Germany, what I’ve heard is they’re good at helping the founders go into the mindset of company building. They spend a lot of time with you to help out. I would say it’s not a bad idea for learning really like company building to go to something like TechStars. I’m not sure about Y Combinator for gaming because it’s so much business to business.

Q: What is the usual equity giveaway for the support received to take off?

A: The incubators usually take 5% to 10%. But in any case, I wouldn’t give away more than 25% of the company, as you might need to raise more. And usually, in many cases, companies need to raise more than one round to get where they want to go. So think about saving your equity, save it for your employees who join later so that you can give them stock options. Because that’s something that I’ve seen helps a lot; if you can hold on to your shares as long as possible because then you can attract people who then will stay with the company for a long time and they’re aligned with you as well since they’re owners in the company.

Q: If, as a first-time entrepreneur, you’ve already raised too much too early, but you see potential big growth ahead, what’s your best strategy to recapture the value moving forward?

A: I could approach your dilemma here, in the sense that you’ve already raised a lot of money. But then you want to raise another round, and then you’re diluting your shares constantly. So one way to fix the cap table is to create an option pool for the founders as well. This is something that I’ve seen in a couple of companies where the founders are giving back more shares basically, later on when the company is kind of like at the point where new investors don’t want to invest because the founders and the management had such a small stake in the company. It can help to actually create a special option pool. That gives back ownership to the founders. It does happen sometimes.

Q: At what point should you allocate an option pool, and what should be that percentage?

A: I recently wrote a blog post about this topic. You can find it with the name Stock Option Allocations.