Why is early stage funding tough to find for game start-ups?

Jay Chi has a theory about the games industry and he's putting a bunch of money where his mouth is. After more than a decade as an advisor in the industry with McKinsey & Company, Chi formed Makers Fund last year to invest in early stage gaming start-ups.

The venture capital fund's portfolio already features more than a dozen companies, including stakes in Bossa Studios (Surgeon Simulator, Worlds Adrift), Alex Hutchinson's new Typhoon Studios, and Tiny Build (No Time to Explain, Punch Club). However, Makers Fund isn't just investing in companies that make games. It also owns a piece of market intelligence firm Superdata, esports matchmaking platform Faceit, and streaming middleware outfit Genvid. The common thread among all of Maker Fund's investments is that they fall in line with Chi's central thesis.

"The innovation velocity of the gaming business correlates very highly with periods of industry dynamics which favor the small companies, the small start-ups," Chi told GamesIndustry.biz. "This is generally true for any industry, but it's really true for gaming."

"Every couple of years there's basically a whole new slate of companies coming up, doing new awesome things and the whole industry dynamic changes. And I think this is actually only going to accelerate"

Hugely successful games like Doom, Counter-Strike, Minecraft, League of Legends, Clash of Clans, and even the streaming service Twitch all grew out of smaller start-ups rather than massive corporations, and Chi expects to see the next wave of industry-shaping games and services share similar origins.

"Being a mix between technology and creative media, the gaming business is a very unique industry," Chi said. "What that gives rise to is actually a very quick metabolism in how the industry dynamic changes and opportunity arises. Every couple of years there's basically a whole new slate of companies coming up, doing new awesome things and the whole industry dynamic changes. And I think this is actually only going to accelerate in terms of the speed of change."

The problem, according to Chi, is that the traditional investment community doesn't fully understand the games industry and so is reluctant to get involved in seed funding and Series A funding for game companies. Once a company has grown a bit larger and reasonably shows it can be profitable, there's little problem attracting funds, but it's a hard slog at first. Even if a start-up finds an individual investor willing to commit $1 million or less for seed funding, Chi said the next step up is the "most critical bottleneck in the industry."

"When it comes to series A, which is like $1 million to $10 million investments, it's right in the no man's land of, 'Well, I'm not sure the idea's going to work, but the money's a little too much,' so individual investors find it hard to come in. So that's where most of the pain point is from an investment perspective."

Chi pointed to three factors that contribute to traditional venture capital's reluctance to invest in early stage gaming start-ups. First of all, games are a difficult enough industry to keep up with when one is embedded in it. While less creative industries may have fairly predictable avenues for expansion and development, the combination of technological and creative evolution makes gaming particularly hard to pin down. Chi compared the process of making games to cooking, a mercurial blending of technique and personal flair, and said a big problem with the VCs right now is they just don't eat enough of the dishes.

"My goal is to show investors and outside people that there's a good, smart way to invest in early stage game companies"

"They're not gourmets themselves," Chi said. "They don't play enough games. They're not deep in the space. It's a cultural product, ultimately, and it requires understanding of taste. So even if they have the right thesis, even though it's changing very rapidly, they may not be able to tell who will be able to cook the best dishes, and they may not know what the good dishes are, too."

The second sticking point is a difference in culture. Chi said gaming CEOs and entrepreneurs tend to be more cordial and tolerant of co-existing with potential competition, perhaps thinking about how to grow the industry more than dominating a field. Traditional investors prefer a leadership type Chi diplomatically referred to as "envelope-pushers," so they wind up more skeptical of gaming outfits that seem to lack that quality.

Finally, if venture capitalists are unfamiliar with the gaming industry, they can't really contribute much beyond money. They might be able to add value when it comes to logistical functions common to any start-up (best practices for staffing up and the like), but they're not going to feel like they're much help from a strategic perspective. This is changing as generations who grew up playing video games and understand the field better begin to replace their game-apathetic predecessors, Chi said, but it hasn't happened yet.

Chi has high hopes for Makers Fund, but he knows that the fund's bankroll isn't enough to move the needle when it comes to the general availability of early stage funding for gaming companies. But like the gaming CEOs he's looking to partner with, Chi would rather grow the scene than corner a market.

"My goal is to show investors and outside people that there's a good, smart way to invest in early stage game companies," Chi said. "There are a lot of great founders and creators out there that want to change the world and have seen the future, know the best days are yet to come, and they're struggling to raise money and find help. If Makers as a fund can help spread the message and spread the gospel a little bit, and in five years time there are more of these game funds out there that can raise bigger sums of money, that's collectively good for the industry."