VCs favor putting their money into esports and virtual reality

Many venture capitalists are shy about investing in games. And for the first nine months of 2015, game investments were down about 35 percent from a year earlier, according to tech advisory firm Digi-Capital. But some brave souls have repeatedly invested in games, and we brought them out again for a talk on what is hot in game investments. This year, the venture capitalists were excited about virtual reality and esports.

Martin Rae, the president of the Academy of Interactive Arts & Sciences, returned to moderate our VC panel at GamesBeat 2015. His panelists included Jason Kay of AID Partners, Sunny Dhillon of Signia Venture Partners, and Phil Sanderson of IDG Ventures.

Here’s an edited transcript of their conversation.

Above: Martin Rae, the president of the Academy of Interactive Arts & Sciences.

Image Credit: Michael O'Donnell/VentureBeat

GamesBeat: As a chunk of the market, esports is approaching a billion dollars. I was a huge skeptic a few years ago. I had a colleague, an assistant of mine, say that this thing was going to be enormous, that it was going to drive a lot of design decisions, marketing decisions, player participation, and fan participation. I couldn’t imagine this five years ago – people paying to play, traveling to watch, paying to watch.

You guys probably know these numbers, but the last League of Legends finals — the only things bigger at this point are the Super Bowl and the World Cup. We’re approaching a billion-dollar business, with 30 percent growth a year on the revenue side. All the major consumer brands are flocking around. There are some opportunities there.

We have some guys looking at stuff all the time, good and bad, and making decisions on where money is going to be spent – Jason Kay, Sunny Dhillon, and Phil Sanderson.

Phil Sanderson: I’m a venture capitalist. Our office is here at the Presidio. I focus on gaming. I have about a dozen game investments. I’ve been in the venture business almost 20 years. I’ve seen a big progression in gaming since edutainment and CD-ROM games, back in the ‘90s.

Sunny Dhillon: I’m co-founder and principal at Signia Venture Partners. We’re an early stage fund based in Menlo Park and San Francisco. Gaming is an area I focus on as well. We have about six gaming companies in the portfolio right now. I’m excited about VR, AR, and esports right now within the game space.

Jason Kay: I’m a relatively newly-minted venture capitalist. This is a new engagement for me. I was formerly in the operating side of the games business at Activision. With Jason Rubin, I worked on trying to revive THQ a few years ago – unfortunately not successfully. I’ve been focused a lot on the esports business. To me this is a big conversation about why it took so long.

AID invests primarily in Asia. We’ve just started to branch out in the U.S. We’re a Hong Kong-based private investment firm focused on technology, gaming, and media. We’re looking closely at the opportunities in esports, especially in esports wagering.

Above: Phil Sanderson of IDG Ventures with Martin Rae of AIAS at GamesBeat 2015.

Image Credit: Michael O'Donnell/VentureBeat

GamesBeat: I had a colleague make a comment that esports is not a business. It’s a marketing strategy. When people are spending a billion dollars, there has to be a business there, but I’d ask you guys to comment. You guys look for leverage. Where’s the leverage? How can you grow a business and make some money? If it’s just a marketing strategy, a marketing spend, where is the business? You mentioned gaming.

Kay: When you look at the wagering business, esports is likely to develop in a way that’s quite similar to how we look at professional sports – football, baseball, basketball. esports is highly asymmetrical. You have a lot of aspirational people who want to be involved in esports, but aren’t necessarily esports-caliber players. You have a relatively small number of elite athletes. It’s not really that different from professional sports today.

If you look at where significant amounts of money are being generated in the traditional professional sports business, it’s obviously team ownership—The analog to that is ownership of the underlying copyrights, owning League of Legends or Counter-Strike, like Valve or Riot. There will be new entrants there. But for people who don’t own copyrights, there’s a lot of money to be made facilitating wagering in legal jurisdictions.

You have specific rules in the U.S. related to skill-based games versus games of chance, but in the rest of the world it’s a largely unregulated environment, both positively and negatively. You don’t necessarily have the controls and the kind of financial security you might have in a place like Las Vegas.

GamesBeat: Does that become a platform play?

Dhillon: I actually think there’s something else we have to consider when it comes to regulation within the space. We’ve just all been made aware in the last week of the betting scandal involving DraftKings and FanDuel. DraftKings is now taking bets for the League of Legends world championship in Berlin.

FanDuel’s acquisition of AlphaDraft means they’ll be playing in the space as well. We have Vulcan and Unikorn that are more specific to esports. Regulation is inevitable, because whenever you do have a form of gambling—2006 saw the Unlawful Internet Gambling Enforcement Act. Self-regulation is not going to be enough. When we’re talking about how much this can grow, it will grow, but within a controlled set of barriers, I think. Is it a means of engagement? It is, and people are going to continue to play competitively. But it’ll be within more controlled guidelines when betting comes into play.

GamesBeat: Where would you look for an investment in that area? Is that going to come back to a platform? Is it a systems investment, a platform investment?

Sanderson: There are multiple areas to invest in all different categories. People love to play games. They love to watch games. 70 million people watched games last year on Twitch. And they love to gamble. You add those together and you’ll find investment opportunities. We’ve looked at a lot of opportunities in companies that create platforms for esports. Those are somewhat limited. There’s team ownership opportunities, advertising opportunities. We invested in AlphaDraft because we believed the model of betting on statistics and creating fantasy teams within gaming was a real category. It is, and it’s growing very quickly. Fortunately, FanDuel felt the same way and bought AlphaDraft.

FanDuel and DraftKings have proven that it’s legal. People want to play these fantasy teams because they’re already watching the games. You don’t just watch these games like you do the NFL. You can play them as well. It’s fun to be able to be in an environment like League of Legends, to be able to play and also gamble on your favorite players. That’s the number one opportunity. There will be advertising opportunities.

I don’t think, as a venture capitalist, that we want to invest in sponsoring teams. That’s more of a movie model. It’s pretty risky. But you’re right. We want leverage. We want operating leverage, predictability, growth potential for technology companies. We find that in models like FanDuel or AlphaDraft.

Above: Jason Kay of AID Partners and Sunny Dhillon of Signia Venture Partners.

Image Credit: Michael O'Donnell/VentureBeat

Kay: Another opportunity that’s very high risk and very high reward — it’ll be interesting to see if any VC is willing to take the risk, even if it’s a publisher-subsidized risk – I don’t think we’ve yet seen a game that was designed from the get-go to be an esports vehicle. We have games that work well in that arena, like DOTA or League of Legends. We have Counter-Strike. But there’s a small number of games that people are playing in esports competition. There’s an opportunity, though it’s very hard to execute, to build a game that you think will work specifically as an esports vehicle, even if it doesn’t necessarily work well as a single-player vehicle.

GamesBeat: I have to believe game designers think about that. Can you get a community involved? But isn’t it just that you find a really fun game, you get a huge community, and they want to compete?

Sanderson: I think it’s more than that. There might be an events business around this. We have a championship series and a season, but that’s at a national and international level. There should be a local season put together around all games. Then you move to a regional and national level. You could create something like college, semi-pro, and pro.

People love to play these games. The betting platforms need content. They need people to be able to bet and they need statistics from the publishers. You can’t do it alone.

GamesBeat: So you think they’re going to have to partner with the publishers?

Sanderson: It can be through an API or maybe an exclusive relationship, but you need the data. You need more data than some of these games currently offer. You need to work with the publishers to be able to get more statistics on individual players to create fantasy teams and play in a fantasy setting.

Dhillon: Vainglory, Super Evil Megacorp’s game, has been a great example of esports being built into a game from the start. They’ve launched Vainglory seasons. That’s just kicked off. They’re organizing tournaments locally, getting a lot of support from the company to engage the community. Community is what’s helped this game grow to where it is now.

Manufacturing a game from the start with esports in mind is not necessarily as easy as it sounds, though. Getting access to things like replay data, kills, AFK time, all the stats you want access to, not every game is able to provide that just yet. Riot does. There are stats companies out there that build on that, people who are engaged in betting and so on. But you’re right in that a lot of people are using esports as a marketing tool to boost engagement within the community and to harbor more competitive gameplay.

GamesBeat: We talked about broader things that you guys would look at for leverage, ways to make money in the longer term. What’s underserved in this area? If you were an entrepreneur, what might be longer-term – not something today, but further off? Where do you think it’s going where someone could take advantage?

Sanderson: There are advertising opportunities. The advertising right now is pretty poor, I believe, within the Twitch and YouTube ecosystems. There are content-sharing opportunities. You referenced replays. Being able to edit replays very quickly and share them with your friends, adding commentary to them and so on.

We try to come up with ideas, as VCs, and share them with entrepreneurs. What I love about our business, though, is that the entrepreneur community comes up with the greatest ideas we can find. It’s a good question, but it’s not our job.

Kay: There are still some opportunities for knowledge arbitrage. Right now it’s very segmented. There are still things that are working in certain territories and not working in others. There’s not any good cross-platform view of the esports business. You have a very small number of games working at scale, but there may be games I’m not aware of that are working in a particular territory and becoming popular. How do you find out about those opportunities?

Most great games, in some way, are derivative of another game. Candy Crush was not the first match-three game. It’s so much about refinement and execution of a good idea. Where is the opportunity to see how something is working in another territory or with another demographic and then broaden that into a bigger audience?

Dhillon: You have the staples we’ve been talking about – Counter-Strike, DOTA, League. Rocket League is another game that just shot to the top, though. The company’s been around since 2004. They had another version of the game circulating for a while. It’s a lot of fun. Would I have been able to call it as something that was going to take off, though? No. That’s the nature of the business. Some of these games will just sneak up on you.

I don’t think that areas of opportunity necessarily exist within new streaming platforms at this point. We have YouTube, Hitbox, Twitch. Already there’s a multitude of platforms there for PC. Mobcrush and Kamcord are offering it on mobile now.

Areas to further engage your community at the amateur level, there are some interesting opportunities of organizing, laddering, and engaging community locally, at an amateur level. Right now a lot of focus is on the pros, despite how the majority of the audience is amateurs watching and wanting to play as well. There are other opportunities to further engage your audience.

Above: GamesBeat 2015 investment panelists Jason Kay, Sunny Dhillon, Phil Sanderson, and Martin Rae.

Image Credit: Michael O'Donnell/VentureBeat

GamesBeat: How long have you been at this?

Sanderson: I’ve been looking at VR companies since the ‘90s. Technology has come a long way. It’s an incredible experience. It’s absolutely the future. Our job as VCs is to figure out when is the right time to invest in the cycle. What you don’t want to do in any cycle is invest a little bit too early, two or three years too early. The amount of money it takes to build a team and put out a product, you can lose that in a very short amount of time. I’m waiting for the right time. I feel like we’re maybe two years away, maybe three, from investing in publishers and developers in the category. But who’s to know?

GamesBeat: Would your first investments be tools, that kind of thing?

Sanderson: I’d think it would be content. I like IP-based content publishers. We made a number of investments in that category. Telltale Games is one. I’ve been on the board the past eight years. Minecraft Story Mode is coming out tomorrow, which is going to be a huge game on all platforms.

Minecraft is one of the most popular IP in history and Telltale knows how to make great games. It’ll be exciting. Next Games, another company where I’m on the board, is based in Helsinki. They came out with AMC’s The Walking Dead: No Man’s Land last Thursday. It’s number one on the App Store today on the iPad and iPhone. Walking Dead is the top title on television today. These games market themselves, which solves the CPI issue in many senses. It’s what people want to play. I like finding publishers who know how to make great games out of great IP. To me that’s the low-hanging fruit in our category.

Kay: In addition to AR and VR, where I’ve been incredibly impressed with how fast things have progressed—I remember Jason Rubin and I went to see Oculus when they had just released DK1. My takeaway was, “Great. This is really early.” I spent half an hour playing Half-Life and six and a half hours lying in bed completely nauseated. I could kind of see it, but I’m one of the least motion-sensitive people I know. If I can’t handle this experience, even playing a pretty slow-paced game, it’s not ready for the mainstream. Fast forward nine months ahead, though, and they solved the bulk of those problems.

Another thing we’re doing that’s not very traditional, we’ve tended to invest directly in content in certain cases. We’re looking at what I call format rights opportunities. Not just standard localization of games or television or movies, where you take it from the U.S. to Asia, but actually looking at the concept and saying, “Does the concept of Game of Thrones, for example, work in localized form for this region, with Thai actors and a Thai-focused storyline that ties into something more accessible to that audience?” We’ve looked at remakes.

We’ve just done one deal that we haven’t announced yet, remaking something that worked well in the U.S. We’re going to completely change it, turning 90 degrees, to make it work in another market.

Above: Jason Kay of AID Partners, Sunny Dhillon of Signia Venture Partners, and Phil Sanderson of IDG Ventures.

Image Credit: Michael O'Donnell/VentureBeat

GamesBeat: Sunny, you were nodding when I mentioned tools as opposed to content. Do you have a comment there?

Dhillon: That’s a good hedge against how long the VR community takes to kick off. Direct to consumer monetization models are a ways off. Spending a thousand dollars on an Oculus-ready PC is still a ways off.

I do think that content creation tools, in the early days of a new platform, are a pretty good bet. There’s a lot of content funding right now coming out of Oculus and Sony and HTC. Investing in tools right now, given that a lot of the content out there will get burned through quickly—The Jaunt-Disney deal that recently happened is getting more capital to scale up production and put out more of these four or five or seven minute mobile-first experiences.

Content creation tools — there’s one we haven’t announced yet that works to create better light field technology, making it possible to create content that looks more realistic and more immersive. Investing in these kinds of tools at the beginning, as there’s a surge of demand for solutions on these new platforms.

GamesBeat: A friend that’s a VC up in Seattle, he loves his cocktail stories about things like hearing Jeff’s pitch for Amazon. I always like to ask, because I’m curious, what have you missed? Why do you think you’ve missed it? Are there any lessons in that?

Kay: I don’t think two minutes could over it. The amount of things you can look back at in hindsight that seem so obvious —

Sanderson: One thing I would add, though, talking about VR as a new category—Something I would encourage people to focus on is cloud gaming, which is happening in the next two to three years. I think Apple TV will replace the Xbox and PlayStation in the living room. I’m excited about it in general. We have a little ways to go technology-wise, just like we have with VR, but those are two categories I’m looking forward to. We’ll definitely be making investments there.