E3 Strategy: Understanding the VC money machine

Venture capital (VC) has long been a resource for the game developer and publisher intent on advancing his or her business initiatives. And with the cost of creating and marketing games on the rise, one of the necessities of any competitive organization in either mobile, online, or single-player gaming is to amass one's millions early in the process--to be doled for technology, coders, programmers, artists, lawyers, office space, and marketers.

In these times, there are few, if any, operations run out of garages or makeshift office space nestled above a bar (as Relic started, years ago). Not in these times, and not for the current crop of tech-savvy gamers.

In the last year, waves of venture cap money has rushed into the game sector.

In July 2004, San Mateo-based mobile developer and publisher Sorrent struck first, securing $20 million from Foster City's BA Venture Partners. Immediately thereafter, former EA founder Trip Hawkins raised $13 million for his Peninsula-based Digital Chocolate. Mforma closed a $19 million round of financing from Draper Fisher Jurvetson. In start-up mode, PlayFirst, Inc., founded by former Shockwave game guy John Welch, raised $5 million from Venture firms Mayfield and Trinity Ventures. And Perpetual Entertainment, founded by two former Electronic Arts executives, raised $6.5 million from Softbank Capital Partners. That's only a partial list.

What is the VC investor looking for in game companies today? How big is their war chest? And their budget for video games or mobile games? We asked Craig Cooper, a partner at Silicon Valley's Softbank Capital Partners, what catches his observant eye when it comes to potential investments.

Take note of the picture at the top of this story. Cooper, along with others from Softbank, is probably one of more than 100 venture capitalists roaming the E3 show floor, looking over your shoulder, assessing your game and your game plan.

"For us it's a great place to meet and network on behalf of our portfolio companies, as well as look for new investment opportunities." And that's just part of Cooper's story.

GS: Tell me a little bit about the significance of E3 to you and your organization. Do you attend, and if you do, what is your agenda?

CC: We are there every day. We've got a deep relationship with the gaming industry and, as you know, very strong personal relationships with most of the CEOs of the traditional and wireless gaming companies.

And for us it's a great place to meet and network on behalf of our portfolio companies, as well as look for new investment opportunities. This year we also have representation from our Asian partners, and Softbank Japan will be on the floor. We are using E3 as a basis to facilitate that strategy.

GS: VC money flowing into the game space seems inordinately attracted to mobile. Why is it mobile that is getting the extra-special treatment from the VC community?

CC: I think it's partly because there's not much else that has had the growth and the data behind it over the course of the last two years. We've seen a couple of big firms investing very early in the sector.

GS: Is it smart money?

CC: To be honest, a lot of it is a bit of a herd mentality from the venture companies. They see some early successes, they look at the opportunities available in what is clearly a growing market with wireless, so they rush to get into the sector. In general, the wireless sector has just attracted a lot of attention because of the early successes of companies like Jamdat, In-Fusio, Sorrent, Digital Chocolate, to name a few.

By seeing [where] Jamdat is going, the venture community is looking to replicate that in the sector.

GS: And VC is looking for what?

CC: VC looks for talented, proven entrepreneurs. We are looking for companies that either have strongly licensed properties or IP of their own which they can leverage into the mobile space.

GS: You're a mobile specialist, but the first significant investment in the gaming space from Softbank was with an MMO company, Perpetual. Why is that?

CC: We had been looking to the MMOG space for the past 12 months, prior to my joining Softbank, so that investment was driven through a couple of things. One is obviously the scale of the business that we had seen internationally, particularly through our investment with [Shanghai-based] Shanda and the visibility that we had through the economic potential of MMOGs, and MMOG platforms more importantly.

And secondly, the ability for us to leverage our investment in MMOGs through our international strategic relationships--principally through Softbank Japan, which is a majority shareholder in Yahoo BB and more recently, Gung Ho Online Entertainment.

GS: It seems you just saw a quicker, more significant upside with Perpetual--whether or not it was mobile...

CC: We thought at the time it was very hard to find an opportunity for us to invest in. We took a view that the industry was potentially under threat by the established publishers and some of the major IP owners, such as the entertainment houses, and was looking to withdraw some of its brands and take them back in-house. Some of that is happening today with some of the major studios. For example, [look at] the announcement of EA Mobile recently.

Today, I think the market has changed. I think that the pure-play mobile companies have got just as much opportunity to dominate the industry as the traditional publishers. That's assuming though that the publishers commit the resources, talent, and funding in order to enter into the mobile space.

GS: What tips you off that company X is a valid, wise investment opportunity?

CC: With Perpetual, it was an experienced team, two former EA executives. They were developing what we thought was a superior platform for the delivery, management, and configuration of MMOGs. We wanted exposure to the space. We looked at four or five different other companies and thought this was the best opportunity for us at the time.

GS: What is the pitching environment like?

CC: It's very busy, particularly in mobility. I heard a number that there were 7,000 publishers and developers globally, for gaming. And I think 6,900 of them are out there raising money.

GS: How often do you hear pitches?

CC: We could see a pitch every day if we chose--in gaming of some form--whether from a platform company, a company in game management technology, direct-to-consumer, or wireless MMOG. But, for us, it's a matter of focusing on where we can provide value and where we can leverage that opportunity with our partners, particularly in Asia. And whether there is anything unique in either the business model: playability, technology; or the intellectual property, the subject of that business.

GS: Who's got standing now?

CC: If you look at the global players like Jamdat, In-Fusio, Sorrent, Mforma...these companies are fully funded, fully loaded, and are well positioned to become dominant global players. I mean, Sorrent recently closed a 20-plus million dollar round. There's a feeling in venture that the playing field for the wireless gaming business, at the top level, has been set and that it may be very difficult for a non-established business to raise the type of money.

GS: Are you able to reveal a dollar amount in terms of what Softbank has available to invest?

CC: We have a portfolio [for] investments and our investment philosophy is focused on investing in next-generation broadband businesses. And that is both fixed and wireless. It covers both enabling technologies, and services and applications, for example. Within that portfolio, we have an allocation towards certain sectors but it's not rigid in terms of the dollar amounts that we would invest in gaming.

GS: From the point of view of venture capital, where do you think the smart money will be made in gaming, mobile?

CC: In venture, making money assumes an exit of some form, either through an acquisition or IPO. We have seen one IPO to date in the US market with Jamdat. We're also going to see a number of other gaming companies who will try to come to market this year. Sorrent is a company that comes to mind that would be well-positioned to go public. Mforma would be looking to go public, I am sure, although I think they are going to position themselves as more of a mobile entertainment company rather than a gaming company.

Digital Chocolate may be acquired, that's my prediction. I also think Mergers and Acquisitions activity will remain very strong. I think most of the smaller companies won't be in that significant a position unless they have some proprietary technology or game that has been successful on the decks of the carriers--or they have a licensed IP which is attractive to a large gaming company.

I think there will also be cross-market merger acquisition activity across Europe, the Asian markets, and the Americas in terms of establishing distribution scale and relationships with carriers in each of those markets.

But in terms of the exit opportunities for venture and the actual money-making opportunities for venture, it is a very difficult market to identify opportunities to make money.

GS: To understand the market, do you have to be a gamer, or can you be just an astute observer?

CC: When I first came to the United States I wasn't a gamer. Now I've had three years of exposure to the sector. I'm sitting here at my desk, my PSP is in front of me. It's a sector that I have to be immersed in order to understand where the opportunities are.

GS: Where do you see growth taking place?

CC: In terms of places to invest, I think casual gaming continues to be identified as the biggest driver of gaming--and that's through both online environments such as Yahoo! Games and through the Asian markets.

I think the use of the camera phone and imaging with the new wireless devices is going to be interesting in terms of driving new forms of gaming activities, and some of the location applications which are being developed.

GS: Any companies catching your eye?

CC: One smart company that I have seen, FloodGate Entertainment, is developing a new form of gaming MMOG platform--what they are developing is incredibly unique and will set a new benchmark for wireless MMOGs.

I also think that the direct-to-consumer model is going to be huge. I think it's not a matter of if, I think it's a matter of when--the carriers will open up the networks.

GS: Generally speaking, how risky do you view the game space?

CC: From a venture point of view, it is very risky.

GS: Is there much of a hurdle for business operators to overcome when they seek VC money? Is your door always open?

CC: The door is always open, but traditionally it has been a much easier process for companies to get exposure to firms like ours through referrals from third parties, either other entrepreneurs or people in the gaming sector. In the case of wireless, through institutions like the carriers and people in the wireless value chain.

It's not a matter of calling us up and making an appointment, but I can tell you that we look at every single deal that comes past us.