Fundraising Challenges in Gaming

Raising capital for a gaming company continues to be challenging as we approach the end of July 2024. This difficult funding environment has been this way for over a year as management teams across both early and late-stage companies are experiencing and grappling with a broader tightening from investment groups. This is clearly evidenced by the fact that we saw $14b invested into the private markets of gaming in both 2021 and 2022 and then a sharp drop-off to $2.7b invested in 2023.

Here at the midway point in 2024, it is clear that the fundraising market for gaming has now settled into a new normal. Below is an overview of why it is so hard to raise capital in gaming right now and our predictions on what might change in the coming 12-18 months.

Why is Fundraising in Gaming So Hard Right Now?

1) Gaming is not AI: In VC, there is immense attention, funding, and concentration around the AI trend. In Q2 of 2024, AI deals dominated global VC funding by raising $18.3b (+32% QoQ), which captured 28% of all invested dollars (CB Insights). This is the highest quarterly share of a subsector on record, showcasing the concentration of investment attention for much of the venture ecosystem.

Even within gaming, there are some AI + Gaming deals getting done. Whether it is pure-play companies like Inworld ($117m raised), a game studio using AI as a feature, or a gaming platform using AI functionality as a core value proposition, there are some AI + Gaming deals getting over the finish line. Two of the top ten Technology and Platform deals in Gaming in Q2 2024 were AI-related - Astrocade ($12m Seed) and Play AI ($4.3m Seed). That said, the attention of broader AI investing is certainly pulling attention away from other exciting subsectors like gaming.

2) VCs are between funds: In VC, a firm’s fundraising timeline and deployment timeline are opaque data points for founders to navigate. Yet, they have a significant impact on the investment market around gaming. Right now, many VC firms are actively fundraising for their next fund and thus are not actively investing. A tactic many in the market are taking is to prolong writing the last one or two checks to keep their fund “active” and to not be labeled as “inactive”.

3) Interest rates are holding back liquidity: To be succinct in explaining how the US Federal Reserve, led by Jerome Powell, is impacting the investment landscape for gaming companies, here is a brief overview of the cascading effects of higher interest rates:

1. Interest rates: High interest rates increase the risk-free rate for the capital markets, meaning that risk-on assets, which the VC community is a part of, have a much higher hurdle to justify the risk. This drives the capital markets to go increasingly risk-off to achieve target returns.
2. Lower multiples: As the chart below shows (rates vs multiples in SaaS), an increase in rates leads to lower valuation multiples. This is why valuations have come down across the board, from publicly traded companies all the way down to Pre-Seed and Seed stage companies in gaming.
3. Less exits: With lower multiples, founders and management teams are less willing to sell their companies at such low historical prices, especially after the valuation frenzy of 2020-2022 that they all just witnessed. This reality applies both to M&A (low ball offers) and going public at a price per share that is likely lower than their last private market valuation. As a result, many companies are simply waiting for the market to improve, often leaning on more optimistic vs. realistic time frames.
4. No growth investing: Growth investing is generally defined as Series B up towards pre-IPO. These are typically $20-200m checks from the largest investment firms. These investment groups have largely been on pause in the gaming market because they look to invest in later stage companies that are within 3-5 years of an exit (usually via IPO, yet M&A as well). Yet given that the IPO market is largely closed/quiet and the M&A market is slower, most growth equity teams are waiting for visibility on improving market conditions.

All of the above, as a trickle-down effect, is why the investment world is so closely watching what Jerome Powell is going to do with US interest rates. Once there is movement lower on rates, we expect that there will be ripple effects from Rates > Multiples > Exits > Growth Investing, and that this hopefully kicks off the next growth cycle.

In gaming, early-stage funding is still consistent year-over-year but growth equity checks ($20-200m) are almost entirely absent the past 12 months. This is very challenging for gaming companies that have found success at Series A but need that next level of investment to achieve the next level of growth. For right now, that is on pause.

4) Valuations are low in gaming: Valuations across gaming for Pre-Seed, Seed, and Series A rounds right now are much lower (often by 30-70%) than they were 18 months ago. This shift happened quickly, and many founders have had to right size their businesses, focus on profitability, and/or take on new capital at much lower terms than they would like.

Given that valuations are low, many companies that have a choice are choosing not to raise, which is often the right call and ends up being a forcing function for operational excellence internally. The lower valuations being offered by investors is inherently contributing to a slower deal market for gaming companies.

Predictions: What Happens Next in Games Investing?

It is very challenging to predict what might happen next within the investment landscape around gaming. The macro environment is clouded by wars abroad, elections (especially in the United States), interest rates (all eyes on the Fed), regulatory headwinds (an overly aggressive FTC), and investment sentiment across the capital markets (risk tolerance, VC interest, etc).

However, here are a few predictions for what’s next in games investing:

1. Gaming is a secular trend: Gaming will remain a key focus area for investment firms (VC, PE, HF, etc) that are paying close attention to consumer trends. Gaming is increasingly where consumers are spending their time and money, and this secular trend is impossible to ignore for top tier investment groups.
2. AI inertia will fade: AI investment and inertia will continue for another 2 quarters in the private markets before it cools down to a more tempered level of sustained investment. This will unlock more capital and attention for other subsectors (gaming included) around Q1 of 2025.
3. Gaming VC to remain sluggish: Gaming VCs will remain at a slowed investment pace for the remainder of 2024 and likely through the first half of 2025.
4. Interest rate cuts will be marginal: Interest rates will come down in late 2024 yet likely by only 25-50 bps. By next summer, this is likely only 50-100 bps total in cuts (if that), which is why we think a lowering in rates will disappoint elevated expectations that we will “be back to the good times” in short order. A slight lowering of rates will unlock some excitement and momentum, but not as much as people hope.
5. IPO market to remain calm: IPO markets will be sluggish for another 12-18 months. There are a handful of gaming companies that need to IPO (Konvoy: Gaming IPOs Watch List), and we expect many of them to pursue the public markets for liquidity. Yet our prediction of a measured response to interest rate cuts is reflected in this prediction of improved yet measured IPO markets, which includes the gaming companies that are poised to go public.
6. Valuations will stay low: We do not expect much change in startup valuations in gaming for the next 18 months. We will stay in this valuation range for the time being.
7. Growth equity will unlock: We are most bullish on the unlock of growth equity checks in 2025, as their 3-5 year time horizon will be well timed with lower valuations in gaming alongside a visibility on improved exit environments on the midrange horizon. To that end, we expect the growth investment activity around gaming to dramatically improve in 2025 (likely $1-2b of net new equity investment is our expectation).

Takeaway: We expect that fundraising in gaming will remain challenging for the next 12 months for most companies. We believe that the broader macro environment around rates, elections, IPO markets, and lack of liquidity are putting broader pressure on the entire market around private investments. Within gaming, valuations will likely remain lower for longer yet after a few marginal rate cuts, we expect growth equity checks to unlock in 2025 (which will be welcomed news for the best operators of the trailing 24 months).