What is venture capital?
In its broadest sense, the term “venture capital” can mean any source of finance from investors seeking a return on their investment (including even angel investors). However, most financiers and others in the “VC-industry” would understand the term to refer to institutional funds whose main business it is to invest money in a portfolio of early stage businesses with a view to selling their shares after a certain period (typically between three to six years) to achieve a return.
Although the majority of venture capital funds do not invest in the games sector, this trend is changing as more and more funds are looking for opportunities outside the heavily saturated investment markets of pure technology or online businesses.
How can venture capital help your studio and what are the main considerations?
Bringing on a venture capital fund as an investor in your business has many risks and challenges. Here are some of the key issues to think about.
- Right timing – a fund will typically look to invest at least £1m in a business. With such a sum, a fund will usually only invest in a business that has a track record or some market data that verifies that the business is past the ‘idea’ stage. For games companies therefore, especially those that have only recently formed, there is little point approaching funds at the ‘concept and design’ stage and you should wait until you can show the fund tangible evidence of your progress in executing your idea (such as statistics on market traction, alpha/beta version interest etc.). However, there are some early-stage investment funds that may consider smaller investments in games companies that have not yet reached the testing stage if they identify clear potential in an idea or concept.
- Business plan – integral to your pitch to the fund will be a detailed business plan that the fund will expect you to have prepared containing comprehensive coverage of your financial figures including a breakdown of costs, revenues and cashflow for the business, use of the investment funds and expected further fundraisings required not just for the current year but three to five years into the future. As a ‘hard-nosed’ investor whose focus will very much be on the bottom-line, you should expect the fund to very carefully scrutinise your numbers!
- Term sheet – a fund that is interested in investing in your business will likely provide you with a term sheet setting out a summary of the key commercial and legal points of the deal. Although usually non-binding, it is important that you obtain legal advice before signing as it can be difficult to renegotiate these points later in the process. The most important term in this will be the proposed valuation of your company which will inform the shareholding stake that the investor will take. Do not be afraid to negotiate any part of the term sheet (within reason) – investors will expect it and it would be odd if you did not question any part of it!
- Due diligence – once a term sheet is agreed, a fund will likely begin a process of asking a long list of detailed questions about your business in a process known as ‘due diligence’. If you are new to the process, the number and repetitive nature of the questions can feel overwhelming at first. However, from the investor’s perspective, it is trying to cover all its bases and flush out any areas of risk in the business. For this reason, some businesses seeking to raise money from venture capital funds perform a “house-keeping” exercise with external advisors in the run-up to the process. This way, you can resolve problems head-on and not on the back foot and facilitate a cleaner and therefore smoother due diligence exercise for the fund.
- Take a step back… - remember that bringing on a major investor into your company will require you to concede a certain amount of control over your company. You should try and pre-empt any sensitive issues at the term sheet stage and therefore discuss and agree a common approach with the investor so that there are no surprises further down the line. Getting rid of an unhappy shareholder is difficult so it is important for you to understand exactly how your arrangements will work with the investor going forwards.
What is private equity?
‘Private equity’ is another term with many different meanings, however, in the investment context, the term is usually used to refer to ‘private equity funds’. These funds differ from venture capital funds in that they normally buy established companies outright rather than investing in minority shareholdings. Growing games companies are therefore unlikely to cross paths with ‘private equity funds’ until they are much more established.