European gaming’s venture capital problem

In the new world order of web, mobile and social gaming, the concept of independent studios relying on publishers for development finance has, for many, already been consigned to history with the tag ‘do not revive’ on its toe.

In this new reality, bootstrapped self-finance and early commercialisation fuel development. However, for many of the most successful companies venture capital has provided a crucial supplement to these, accelerating growth and allowing companies to take the sort of risks that self-financing often precludes.

Some $2.1bn of this sort of finance was raised in 2009 and 2010 alone but, a closer look at the data reveals a stark reality; that Europe not only lags a long way behind North America but has seen its share of global investment collapse in recent years compared to the US, Asia and the rest of the world.

For this month’s column I want to delve into this, explore why it has happened and what the implications are.

SOMETHING VENTURED

Between 2000 and 2008, privately held games companies in Europe raised some $830m of venture capital financing (20 per cent of the global total), second to North America (primarily the USA) whose $2.9bn represented 69 per cent, and well ahead of Asia and ROW (11 per cent).

For the network gaming boom years of 2009 and 2010, North America consolidated its lead with 81 per cent of total finance raised, Asia/ROW grew to 12 per cent and Europe collapsed to just seven per cent.

Given that Europe represented over 30 per cent of the global games software market in 2010, why does it punch so far below its weight with VC investment?

For a start, Europe generally invests less than the USA. Although Europe houses a large and active VC community of over 700 firms that invested €3.5bn across all sectors last year, the USA’s 800 VC firms invested a remarkable $22bn in the same period (source: EVCA, NVCA).

This investment chasm undoubtedly reflects on the territories’ respective games investment stats and can itself be attributed to several factors; significantly smaller average fund and deal sizes in Europe, and, I would argue, a greater level of risk aversion inherent to European investors.

For the games sector specifically, there are a number of additional factors behind Europe’s under-performance.

The paucity of major stock market listed games companies in Europe compared to Asia and the USA means many VCs will see their only viable exit via a trade sale – in contrast to the IPO potential of other sectors – which in turn reduces the likelihood of investment.

This also contributes to another problem in Europe; ignorance about the global and in particular local games sector as investors have less actual company – and market – intelligence with which to compare prospective investments.

Truth be told, Europe has a history with a number of terrible games company investments and although the US market has also suffered from failed investments, it would appear European investors have been more easily deterred by these past failures.

CULTURAL DIVERSITY

Thanks to its multitude of different cultures and languages, Europe is clearly a more difficult market in which to scale a games company.

Although based on anecdotal evidence only, I would also suggest that European games companies themselves can be more conservative than their US counterparts, less prone to take risks and less willing, as a result, to incorporate third party finance in their growth plans.

The implications of this relative under-investment could be profound. VC funding has helped developers retain control of their own creative direction, intellectual property and, ultimately, commercial destinies.

It has encouraged risk-taking, spurred the creation of new games markets and propelled start-ups to market leading positions, often overtaking companies reliant on organic growth alone.

Europe is strong in one corner of the network games market, browser MMOs, but comparatively weak in most other; particularly mobile and social where, with a tiny number of exceptions, investors have few European candidates to choose from, with the top 100 leader boards dominated by North American and Asian companies.

There is clearly a virtuous circle in the US where investment has led to growth and successful exits which have encouraged further investment.

In contrast there appears to be a vicious cycle in Europe: underinvestment leading to underperformance which contributes to underinvestment.

Europe clearly has the potential to create new global games powerhouses, but to date it has rarely realised that potential. Breaking this vicious cycle is therefore critical for Europe’s future.

This will only be achieved gradually as more successful exits – or other incentives such as tax breaks – encourage more investment, and as more European games companies enter new markets and, like
their US counterparts, plan growth around
VC finance.