MONEY

Why Venture Capitalists Hesitate to Play Games

Advertisement

NEW YORK -- The video-game industry is booming, but venture capitalists aren't playing.

VC investments in games-related start-ups have been sporadic, even as video-games sales are surging. One factor is the broader downturn in VC activity since the late 1990s, which has hit most categories of start-ups. But another obstacle has been the hit-or-miss nature of the video-game industry, VCs say.

"Historically, in the games business, a lot of companies really succeeded by hitting it big with one blockbuster," says Jon Callaghan, managing director at Globespan Capital Partners in Palo Alto, Calif. &"As a VC, it's very hard to invest in that."

Only $37 million was invested in games-related firms in the U.S. during 2002, down from $66.9 million the year before and a peak of $295.3 million in 1999, according to Thomson Venture Economics, which tracks VC data.

At the same time, U.S. sales of video games and consoles jumped 10% to a record $10.3 billion in 2002, according to NPD Group, a consumer market research firm. Titles ranging from "Grand Theft Auto" to "Madden NFL" to "Super Mario" led the way.

The video-game market is dominated by established players such as Electronic Arts Inc., Sony Corp. and Microsoft Corp. Electronic Arts is a venture-capital success story, but it's been around since 1982, with VC backers including Ben Rosen long cashed out.

These market leaders dominate the shelves of retail stores, making it hard for startup publishers and developers to get attention. Also, for every top-selling game there are dozens that don't catch on, making the business a low-margin proposition for many firms.

Even online and downloadable games, which independent developers have had some success selling, aren't drawing a lot of VC interest. Independent developers that aren't controlled by leading publishers have a tough time getting funding because VCs want to see a meaningful revenue stream and a track record of titles that sell.

"The whole gaming area for VCs hasn't been a big item for them in a while," said Jesse Reyes, vice president at Venture Economics. "The barriers to entry are too low and it's a fairly low-margin business."

There have been some bright spots. Sorrent Inc., a San Mateo, Calif., publisher of games for wireless devices, raised $5.5 million in Series B financing in April. The round was led by Globespan Capital Partners, with Callaghan taking a seat on Sorrent's board. Previous investors New Enterprise Associates and Sienna Ventures also chipped in.

Some investors see a lot of potential in cell-phone gaming because the wireless distribution is inexpensive, leading to higher profit margins. Also, the market is still small enough that it hasn't prompted the industry leaders to make a big push into wireless.

"It's a big market for a nice little start-up," Mr. Callaghan said.

Sorrent develops and publishes games that wireless carriers sell to customers for anywhere from $2 for a 30-day license to $8 for permanent ownership, said Chief Executive Scott Orr. Games like basketball and football can be played on phones with color screens.

Globespan typically doesn't invest in entertainment firms. But Mr. Callaghan said he was drawn to wireless gaming because it could be the first big premium data service for cellphones, which aren't just for talking anymore.

Mr. Orr said Sorrent had an easier time raising money in the Series B round than the first round in 2001. But the hunt for VC funding remains difficult for most games startups. Just ask Adeo Ressi, chief executive of Game Trust, a New York developer of software used to run multiplayer video-game tournaments on various devices.

Formed in February 2002, Game Trust is still running on angel and management funding. Mr. Ressi has spent much of his time searching for VC backing, including a public pitch at a business forum sponsored by the MIT Enterprise Forum NYC.

So far, Game Trust hasn't raised a penny, although Mr. Ressi said some term sheet offers are pending. "I would say by far it's the most difficult financing market I've ever experienced," said Mr. Ressi, who previously raised financing for other startups.

Mr. Ressi thinks some segments of the gaming market, particularly on the infrastructure side, have higher potential to draw VC interest than other industries. It's just that few VCs are pulling the trigger on deals.

"The VCs are waiting for demonstrable results," he said.

Mr. Loftus is a special writer, covering the information-technology sector for Dow Jones Newswires.

Copyright © 2004 Dow Jones & Company, Inc. All Rights Reserved

Last updated: Feb 1, 2004




Register on Inc.com today to get full access to:
All articles  |  Magazine archives | Livestream events | Comments
EMAIL
PASSWORD
EMAIL
FIRST NAME
LAST NAME
EMAIL
PASSWORD

Or sign up using: