Funds and Games

Funds and Games

By Develop

April 23rd 2009 at 2:27PM

The games industryâ??s historic resilience to recession and its apparent imperviousness to the current turmoil in the financial market have been debated far and wide.

Most commentators have pointed to the remarkable growth experienced in the games retail markets in 2008 as evidence of the industry’s Herculean strength and studied indifference to its dire macroeconomic context. The unprecedented depth and scale of this downturn hasn’t put most commentators off their rosy-eyed futurology, but there is one impact of the downturn that has been overlooked, and which could prove disastrous for the industry should it continue or worsen.

Put simply, in the last four or five months there has been a collapse in venture capital and, more broadly, private equity funding for privately-held games companies. And I deliberately use the word collapse. Private funding for games companies worldwide since the start of 2009 is tracking down a staggering 60 per cent on last year and close to 70 per cent on the year before that. Combine this with the strong allergic reaction banks are currently exhibiting to the idea of lending to most small and medium sized companies, let alone hit-driven ones, and one could conclude that the once-plentiful wellspring of non-trade finance for privately owned games companies is rapidly drying up.

The bullish industry insider may be thinking that the relative success of games would act as a beacon to attract investors and lenders, but this is not proving to be the case. There are a variety of complex reasons for this, which I will quickly present here.

‘NOT IN OUR INDUSTRY, SURELY?’

Most investors will have less capital to invest than they did a year or two years ago, as their own sources of finance will have contracted with the plummeting global stock markets. Many will be spending a higher than expected proportion of their available capital on ensuring their existing investments stay afloat. With the stock markets in such appalling shape, the exit options for their investments will have been curtailed and exacerbated by the fact that the games M&A market has shrunk dramatically too – but that’s a whole different article. They will also have become incredibly risk-averse, making new investments within their comfort zone only. Given that few investors really understand the games sector, and so many distrust it, this will have left few investors willing or able to take a punt on a privately-held games company.

The problems with this situation are manifold. Since the start of the millennium, over $4bn has been invested in privately owned games companies. This investment has enabled hundreds of mostly small and medium sized businesses to launch, attract high quality staff and commercial partners, accelerate their growth and, in some cases, generate substantial returns on exit. It has resulted in employment for thousands of games industry workers each year.

Most importantly, however, this investment has inspired and enabled the sort of innovation that trade finance – i.e. the big publishers – would never even consider backing. Over 60 per cent of that $4bn has gone into network games ventures, mainly online gaming, and it would be no exaggeration to say that the rapid growth and diversification of, and innovation within, the network games market has been underpinned by this external finance. Companies such as Turbine, Mythic, Wild Tangent, Nineyou, Oberon Media, Sulake and CCP Games would not be where they are today without venture capital money.

The danger is therefore that, should the drought continue or worsen, not only will we see the collapse of lots of smaller, unprofitable games companies still in their critical development and investment phase, but there will be considerably fewer start-ups able to pick up the innovation baton and continue to evolve the market. In some ways this may well not be an entirely negative outcome. The bursting of the dotcom bubble at the start of the decade forced a radical rethink of online gaming business models and a Darwinian consolidation of the development market that left only the most commercially able-bodied businesses standing.

There have arguably been signs of this bubble reforming in the second half of this decade with MMOs and virtual world companies the focus of investor over-exuberance, whilst mobile gaming has already experienced its investment boom and bust-precipitated consolidation cycle. However, unlike in the late 1990s, the MMO and virtual world markets can actually boast sustainable business models, so the fallout should theoretically be less severe.

So, for those of you who are VC-backed and still loss-making, I would be urgently focusing on the route to positive operational cash flow as the next cash injection may well be a long way off. For those seeking investment, the doors are not closed completely, but finding the right door may prove a challenge.