Duncan Davidson (Bullpen Capital): In Silicon Valley failure is a feature, not a bug.
04 Feb, 2022
David Lau-Kee is Co-Founder and General Partner at London Venture Partners. He was the Founder, President & CEO at Criterion Software Group, including RenderWare & Criterion Games. Before Criterion, he co-founded Canon Research Europe and headed multi-million dollar R&D in computer graphics, image processing & UX.
By accident rather than by design. Many people in the VC world come from an investment banking background. My background is as an operator. I worked for many years as a founder of a startup, growing and developing my company. In around 2004/5 I sold the games’ company that I’ve been building to Electronic Arts – one of the biggest games publishers in the world at that time – and I worked for a few years to integrate the company in. After working as an operator and a founder I decided to get into VC. And again not by design but by accident. After I sold my company, I was looking for new things. I saw a lot of people coming to me and asking to consult them, to offer them advice, to help them with businesses. That was fabulous. The most interesting companies I found were companies that didn’t have any money, so they couldn’t pay me for consulting. Rather than taking money from them, I would take equity. And then really interesting ones often not only didn’t have any money to pay me – they didn’t have any money to pay themselves or to execute their business, and I gave them money for the pleasure of consulting. So I started off as being an operator in the game sector, successfully sold my businesses, became an adviser and consultant who would take some equity, and then would be deploying capital as well – sideways route into Angel investing. The move to VC happened because in the games industry, where we had worked for many years, there was a fundamental lack of understanding on the financial side of the business – both sides. VCs didn’t understand the games section of the games industry, and games companies didn’t really understand how finance works and the value they could bring. The part of what I tried to do at the beginning with LDP, along with my co-founding partner David Gardner, who had been in EA for 25 years, we were trying to breach the gap between games guys and finance guys, to create a mutual set of understanding, because a capital flow into the game industry would help everybody. It sounds too general, like trying to help everyone, but our perspective was as the games industry grew, we also benefit from that. So, I’ve started as an operator in the games industry, and we created LVP to be a specific games-focused VCs, to bring that level of deep operating understanding experience into the VC market for games.
One thing that surprised me was the need to maintain two simultaneous truths. One is knowledge about how the VC industry works and how returns distributed. VC’s returns are based on these very very outsized winners. When you invest in the early stage, 50-60-65% of the companies in your portfolio won’t succeed – and that is very sad. And one truth is an understanding that actually most of the companies you work for will never succeed. Against that, you have to maintain a simultaneous complete and utter belief that these companies will succeed because you, as a VC, have a full portfolio of companies, but a founder has only one company. And it is all that matters – that one company. As VCs, we have to balance those two truths – that understanding that, actually, a lot of companies won’t succeed and that every person we invest in has only one company, and we can only invest if we have complete 100% belief that this one will be hugely successful. For me, this was a fundamental early-on surprise. Maybe other VCs have different ways, but we have a small portfolio, we’re very hands-on in what we’re doing, we’re very involved in our companies. Because our experience comes from operation, we’re kind of obliged to spend that time with the company to try to help them to reach that level of success.
Partially because we are very sector-focused, we don’t have anything strange. But one interesting company that we invested in is the game company based in Berlin called Klang. It was 3 guys with no startup experience and no real business experience. One of the guys had worked in a company called CCP in Iceland and had technical skills in terms of games. Another guy was a very strong technologist. And the third guy, the CEO, was a fashion designer. Very mixed, very strange background. When we saw them, I guess, dozens or hundreds of VCs already have checked them (and a good VC supposed to check off everything) and nobody put any money. Apart from their ambition, and their passion, and their determination to succeed and not let go, there was pretty much nothing else there. They were probably the most interesting. We put a small amount of money, like $250k into them and were prepared that it’s probably not going to work. But we worked quite heavily with them to try improve their ability to connect with other people within the industry, to build a network for them. That was in a while back, 5 or 6 years ago. Subsequently, they raised something like $40M, gradually leveling up their capabilities and having phenomenal vision they were able to create a fantastic team and bring strong co-investors in there. Probably, that was the most unusual, because they had very very little, but have strong ambition. Maybe we also have a recognition of ourselves back in 30 years.
About 600 pitches. About a half of those, we reject very quickly, because they are outside of our thesis or have no real venture-backed proposition. About 100 make it through to the second filter, when we begin diving and looking in more detail on the competition. Some kind of soft diligence. We invest in 4 to 6 projects a year.
We invest in the game ecosystem. It breaks down roughly into 3 parts: games themselves, services and technologies around games or facilitating games, and platforms that host games or create social networks around games. There is a lot of areas that touch games, but out of these 3 interesting for our parts. Like VR. Several years ago everybody was hugely excited about virtual reality and games. We got a lot of work trying to analyze if there is any real future of VR in games and we just could not find any compelling reason that there will be strong growth in games around VR. More than that, our sense was there was no first-mover advantage, and you might as well wait until the success parts are proven and then look for startups that are going to deploy their expertise against that proven parts. And this was also odd because usually, the first move has a strong advantage. So that’s an area where we didn’t invest, still haven’t, and, unless things change, probably wouldn’t.
Usually, we enter at the seed or Series A-stages. We do some Angel stuff, and we’ve invested in people before they even form their companies – the first money in and helping them establish the company in the first place. About Series A level: there is no rule here, but usually, this is a follow-on of our portfolio companies. Probably we wouldn’t do Series B and we will certainly never enter Series B directly. Therefore, it is a seed going down to Angel and going up a little bit to Series A.
No lower limit, but we’re looking to deploy anywhere from $0.5M to $2.5M as the first ticket, reserving the same amount for follow on. We like to syndicate, like working with others. Sometimes people come to us with the deals they want to participate in because we are experts in the games space, so we don’t lead these deals and a check may be smaller.
Show! This is one of the things we work with our founders as well – the understanding of pitching psychology. Because we are early stage, this is one of the things we measure our own success – the ability of our companies to go on and raise later rounds. I was talking about this distinction between Travelling in Hope and Travelling in Expectation, which amounts to in is it a vision pitch or a KPI pitch. Almost always, because of the stage, we’re looking for a vision person with an awareness of the importance of KPI. They need to know how they should be measuring themselves, know what is a good measurement in their specific sub-sector. They shouldn’t achieve them yet. We must more like a high-level vision. Again, when somebody comes to us with a game concept, it’s almost always not interesting. We don’t invest in games, we invest in businesses that potentially produce games. When you come to us, it is much better to say, “You know what? There are hundreds of thousands of players who have been underserved and don’t get what they need, and that is why.” Or, “We’ve seen what happened with lockdown around the world and how generation Z is interacting with each other, and what they want.” Some high vision concepts that become high-level thesis that is worth exploring for what games might be. For example, we know that in a certain type of games, in PVP (player vs. player) might be a lot of toxicity, which, by the way, adds to the fun because it adds to the competition. But about 50% of the whole world would much prefer to cooperate. And we’ve funded some companies that brought us a specific thesis that cooperation is underserved, and the mechanics of how you create social networks around that is really interesting. It was back in the 2000s when games started to move online to much bigger demographics. Today games are the social spaces where people congregate to spend their time. Look at Fortnite with all the transactions happening within the game. Look at Roblox – it touches about 70% of the 13-20 generation in the US. It’s gigantic. And what they do? They’re not necessarily competing against each other, they are creating or building something, socializing with each other, some are engaged in commerce. “Game” is too small a word for all these experiences. That’s what is exciting us and what we’re going into.
It really depends on us. Sometimes we see and engage with a company and it might take a year before we build conviction enough to invest. It doesn’t mean that we won’t be talking with them for a year: we might be working with them, helping, throwing questions or suggestions to see how they develop. In a more usual case where somebody has a complete proposition coming to us, the process looks like that. In comes a pitch deck of some sort. If it passes the first filter, and I look at everything that comes in, being the first filter, and it falls into our themes, investigate it with my team or using my network. We look at who are the other players in the space to get a little bit more information about it. At that stage, I’m looking for the uniqueness of the proposition, for the strengths of the team, at have missed something obvious. If that looks interesting, we move to the next stage which will be a call from me or one of our team members. If that works out well, we involve other people in the team. We are all professionals in the games industry, and when somebody spots something interesting and it passes that first filter, I’ll take it to the wider team to assess the level of general appetite for it. Then several team members will have their follow-up calls with a company, asking different types of questions. Then we do background diligence, consulting our network. I like when we’ve already known people who come to us or they have reached us through somebody we know. There were cases when we knew within 2 hours that we will be investing. The whole process took us longer, obviously, but we made a decision emotionally in a couple of hours. Usually, it takes at least 2 weeks, maybe 3, and at least 2 or 3 meetings plus our background work to bring us to the point where we are interested in doing something and then there’s a discussion about what the economics may look like, terms, and so on before we get to the term sheet. And then it may be 4 or 6 weeks for the long-form documentation to come together and the Investment to be made. I’d say, 2 months beginning to end would be a good target, can be longer, but rarely shorter.
In terms of entrepreneurial capability, we’re looking for a big vision and a drive in the sense that they can conquer the world with their vision. In the games industry, like maybe in the film industry or likes, people often get there because they love the essence of it. That’s fabulous! We need more than that, though, we need people who not only love the essence of what they’re doing but also love the idea and are determined to build a very very large business. That’s one thing we look for – passion and understanding of what they’re going to build. We often see people who have no experience in the games industry. That’s very difficult for us because there is so much that you need to learn and understand to succeed, so we’re looking for deep sector-specific knowledge and even for sector-specific success as well. We are in the cycle of the industry when a lot of aspects are mature and therefore there are people who know what success looks like. We’re looking for integrity. I got into VC as a passion thing rather than a career, and unless I really enjoy working with the people that I’m investing in, I won’t invest in. We’re looking for a capable leader who can communicate that vision. Someone who listens. Sometimes, you have somebody with such a strong passion and strong belief who is very defensive about that and will defend that belief. That’s good unless this defense blinds you to things you’re not seeing, like other opportunities. We need somebody who is passionate about what they do but passionate about listening and learning and understanding how they can improve and get better.
My founding partner David Gardner, I know, would have the opposite answer. I prefer Woz, Steve Woznyak.
Yes, just one company we’ve invested in was a single person. And it worked because I had a long history with that person, I’ve known him for many many years, worked with him previously. He is a very strong technical founder. I could understand the technical breakthrough he’s made, so we invested on that basis ultra-early. Because it was just him and technology, we had to work quite a lot to try to establish what to do, what is a business should look like, what would you need to think about. So, we have done it and we will probably do it again if the right person came with the right approach. You need to understand that a part of the reason why we invested is the ability of the founders to be able to build the team – that’s an actual skill.
Lack of integrity is a big one. Again, because we are sector-specific and because we’ve worked in the games industry in all of our careers, we have a huge network and can get feedback from people about almost everyone who is active there. There were deals we have thought that we would do, but then they didn’t pass the integrity check. That’s a big red flag for us. Closed-mindedness is a red flag for us well. As a founder, as a leader, if you’re not prepared to listen and learn, you lessen your capabilities to have growth and really succeed. The other reason is that, because we are a small very sector-specific VC, if you’re not willing to listen to us and use our network, our experience, and insides we can bring, connect with our portfolio companies, then go and get money from somebody else. As a game developer, you might have one person who specializes on user acquisition, for example, but we got 15 of them through our portfolio. Why not talk to them, why not listen to them, why not work as a group? We are trying to leverage that strengths in the network by bringing together people from different portfolio companies to work together on specific tasks and challenges. We call it the LVP platform. To learn about HR or finances is easy, you can read books. But if you’re looking for some very deep specific knowledge related to games, you’d better be ready to listen to people who walk the same road or the only person working in the industry whom I know. There are some other red flags but these two – the lack of high integrity and inability to be able to listen, to learn, and to use the network – are really big for us. As is the converse: unwillingness to share your experience and knowledge and capabilities. We succeed and thrive on the net of the internal network effects.
We have fund’s target. For the individual companies, we don’t have a multiple in terms of money. As a rule of thumb (and I think all VCs do the same) unless we see that a startup has the ability to return the whole fund, we don’t invest. Giving the fund size, it means that we’re looking for companies that can get a $500M valuation or more at the exit.
Typically for a seed-stage company 20-30% dilution is reasonable for enough money going in to take it to KPIs or whatever you need to get your next round. There are some companies at such early stages, where the risk is so high, where we’re going to be so deeply involved on an operative basis, that we can take even more. We want less than 50% of the company to be in the hands of outsiders after they’ve done Series A and after Series B the founders and the company should have less than 50%.
All the time. There’s a company in Nottingham in the UK called Lockwood. It’s run by Halli Bjornsson, an Icelandic architect. We saw them very early on in their journey and really liked their thesis, we just thought the team wasn’t quite right and we just wondered whether they have the right level of ambition. We didn’t invest at that stage. I’m still friends with them and I so regret not to be a part of what they do. He was my mistake: Halli is Icelandic, he is a viking, and vikings are fierce. Even when they seem placid and easy going, they still want to conquer the world. And I didn’t see that he actually wanted to conquer the world – I just saw this very easy going person. I misjudged him.
I think, we went through a big journey because of COVID-19. When it first started a year ago there was a real sense that we would move back to fundamentals rather than visions, investing more based on KPIs. As things played out, we moved back to visions. We are looking now at a very similar thing, maybe just more leaning towards social experiences rather than non-social experiences. COVID taught us that people want to interact more in virtual worlds and games. That was a bit of learning for us, it accelerated what we saw happening anyway. Of course, we never used to invest without meeting people, spending time with them – that changed. But the whole world learned to interact in a different way. We had to learn that as well.
An opportunity. It’s a mistake to think that COVID changed things for the games industry – it was accelerating things that were inevitable anyway. More and more people were choosing to spend their time digitally, connecting, entertaining, or learning. There is more and more participation rather than just consumption. Also, other forms of socialization by young people were taken away, and games were a beneficiary of that. Also, COVID accelerated the inflow into games by people who didn’t play before. Although they might not identify themselves as gamers, what they do is interacting with their friends in a games environment.
The 2008 financial crisis, again, was good for the games industry, because games were small discretionary spends, and as people’s finances became constrained and they couldn’t make big purchases, like going on holiday or out for a big expensive meal, they still could spend smaller amounts on games. Games were countercyclical in the short term. COVID is very different: it’s not about a switch of spending – it’s a switch of where you place your time rather than where you place your money. That is much more interesting because when you spend time in something, you become familiar with it and it becomes a part of your broad world of the things that you want to involve yourself in.
I’ll give you 2 games and 1 non-game. Unity game engine had a huge impact on the industry. Before Unity, it was game developers and game consumers. Unity brought to those consumers who loved games and played games and had some technical capability and skills with tools to be able to build games. For me, that was that huge step forward because it blurred the boundaries between the creators and the players. I saw Unity when they were just, like, 10 guys sitting in a room in Copenhagen through to this year when they have a $28B market cap. And they’ve stayed true. I remember sitting with them in Copenhagen, talking about the democratization of game development, enabling tens of thousands of people who love games and have technical capabilities to become a part of the games industry by having tools allowing them to develop their own games. The messages are the same today. The second one is Supercell. It was really interesting because they turned the whole system upside down. I’m in the games industry for 30 years, and way back then there was a way of working – very top-down things. There were the authors that created games, finance people and someone who is responsible for the business, a big team of developers, project managers, and producers – anywhere from 10 to 100 people making the game. Supercell turned that upside down saying they don’t need that complicated structure. They created a different, cell structure where a small group of 5-7 people was responsible for a game from beginning to end. That was really interesting to see. The timing was very good as well because the smartphone era just started. They were a company of about 200 people making the same amount of profit, like a billion dollars a year, as Electronic Arts which had 10 000 people. That was what was startling. The third startup is BioNTech. Again incredible story. It started in 2013 with people coming from different perspectives and different countries, by immigrants. Look how much the world owes them and companies like that now. For me, it also to makes me glad that I’m not responsible for investing or making decisions that are life or death. I’m investing in games. What’s the worst that can happen? People don’t have fun – that’s the worst. I’m happy with that.
Well, it hasn’t happened yet. I’ll tell you a story. There’s a company called Riot Games – a hugely successful fantastic company based in the US. It was another company called Riot-E, Riot Entertainment – a Finnish company doing very early SMS content mobile games even before iPhone. They raised a ton of money (I can’t remember the amount) and proceeded to act like crazy 1970s rock and roll bands in terms of how they spent the money and how they wasted it – amazing stories of hedonism and excess. There is a video documentary on this company, Riot-On!, and anybody who is interested in salutary tales of bad investments can watch it on Youtube.
Digital game space transcends any single game mechanics. There is a board game itself with the rules and mechanics, and that’s fantastic. When you look at the digital games industry, you pull back from that board and see the whole ecosystem around, at everybody who’s playing and how they interact, you look at the leagues, and so on. We are investing in the sports, the leagues around the sport, in people competing, in the leaderboard, etc., and it’s much more than some specific game mechanics.
I’m quite lucky. It wasn’t a career choice because I had a career in building companies and making games and building games technology for many many years. I moved into VC because it was a fantastic use of what I’ve learned plus the ability to be able to share that knowledge and to join other people on the ride I had. I’m very lucky, because of how we operate I can spend my time deep diving and learning about topics that I don’t know anything about. Maybe one day I will spend even more time on this deep dive and knowledge gathering about where the industry is going rather than on hunting out of the next startup.
First is game-specific: Don’t pitch the game – pitch the business. Second: Don’t ask us to sign a non-disclosure agreement, because we’re VCs and we can’t. And the third one is a recommendation for reading. There is a book everybody who is raising money from a VC should read – Venture Deals: Be Smarter Than Your Lawyer and Venture Capitalist by Brad Feld and Jason Mendelson. That book will tell you everything VCs care about when they’re putting together a deal and term sheet. You will know what they’re looking for in a term sheet, why it matters, and it will put you in a great position to be able to negotiate well. We want founders to be as well informed as they can about what matters to us and what matters to them in order to build a strong partnership.