What I think about games investing in 2024

A conversation with Aaron Bush at Naavik.

Earlier this week, I sat down with Aaron at Naavik to discuss how we at F4 are thinking about games investing in 2024.

Find the full conversation at the links below, and read on for some edited highlights.

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What F4 Fund is focused on today

F4 is a pre-seed and seed fund investing in the future of media and communications. The thing that's interesting about games is that of all the content industries, it’s the first to adopt new technology, business models and distribution approaches. A lot of the things that hit games first are now rippling through all of media, and we want to be at the center of it.

Why most game studios shouldn’t raise venture capital

Venture capital is an asset class best suited for industries and companies that can deliver rapid growth. Gaming only does this periodically, usually after a platform shift-driven market expansion. Outside those periods, it's been quite hard to deliver venture scale returns.

Mobile, especially pre-ATT, was well positioned to deliver that growth. You could build a game relatively cheaply and if it worked, pour money into scaling. It's much harder now though, a tougher game for startups vs big companies.

Looking at game studios specifically, a lot of their most durable competitive advantages are built over long periods of time. Most of the big independent PC gaming success stories like Larian, From Software and Supergiant built their advantages over years or multiple decades in some cases. Reputation, brand, audience, teams, tools, culture - none of that can be built quickly. In most cases, a large infusion of capital is not going to help very much.

Which game studios should raise venture capital?

If you think you can sell your company for at least 25 times your seed valuation within 7-10 years, consider venture capital. Have good answers for what elements of your plan and market make that growth profile plausible. Be honest with yourself about whether you really want to do this, as many developers would prefer to keep building games independently rather than aim for an exit. If that's not your goal, investigate other funding options like bootstrapping, publishers, crowdfunding or angels.

The best fit for venture are companies that could become larger than a single game company or can build their game into a platform or better yet an ecosystem, creating an uncapped return profile.

You also probably also need to show a path to recurring revenue, as the recent struggles of publicly traded publishers that lack this have demonstrated.

VCs look for a scenario where you could ultimately be worth hundreds of millions or billions of dollars. That won't come just from making a cool game and putting it on Steam.

How do you plausibly pitch a game as a platform at an early stage?

A lot of companies try to build platforms out of the gate and it's very challenging. I think this is particularly true if you are proposing to build a horizontal platform like Roblox - i.e. one that can address multiple genres and play patterns.

But for games, I think we can expect to see more "vertical worlds". If Roblox is a horizontal UGC platform, games could become vertical worlds - they have an existing game and audience, but are built to eventually allow some players to create on the platform. It's reasonable to have that in early plans, even if it happens later in the roadmap.

Is gaming overinvested?

From the perspective of a gamer and someone who loves the industry, it's good there's a lot of capital out there. We don't know, maybe the industry will expand from things getting funded that wouldn't have 10 years ago when these dedicated pools didn't exist.

That said, I think it probably is a little over invested, if some of the valuations we’re seeing are any guide. My main job as an investor is to deliver good returns to my LPs. At the end of the day, that's driven by a simple calculus - how much are we paying for the stock, and how much can we sell it for on exit?

The truth is, we see a lot of deals where we don't feel adequately compensated for the risk we’re taking at the earliest stages. Because we're not just a gaming fund, we invest across all of media and communications, these price differences are striking.

It’s not uncommon to still see game pitches that often have only a deck or at most a rudimentary prototype, asking for $10-20M valuations even when nothing has been de-risked and a lot of capital is still needed.

Compare that with some other deals we’ve done. For example, in the SaaS space, we recently invested in a company with a product, several hundred thousand dollars in annual recurring revenue growing at 30% month-over-month, raising capital at a $10M post-money valuation. Another recent seed deal we completed was in the $25M range for a company with a few million dollars in annual recurring revenue.

When you put those next to a "here's my cool game idea" pitch with a $20M price tag, it doesn’t stack up too well.

How should founders adapt to the end of the cheap money era, when it’s important to get scrappier?

A recent pre-seed deal we did is a good example of what we look for.

The founder is a genius-level solo developer who is not based in an expensive location, and is building slowly for a potentially massive audience. We are also more focused on systemic games rather than heavily content-driven ones.

One concept I've advocated for is "minimum viable fidelity." Developers, especially those with AAA backgrounds, often set the bar too high for their game's visual quality. However, when you look at successful games, you'll find that people are willing to tolerate much lower quality graphics than you might expect.

It's crucial to understand the difference between making your dream game and building a thriving company. Be absolutely ruthless with scope, and keep your runway as long as possible.

What is underhyped today?

I think maybe VR? As a founder and an investor, you always want to look for disruptions that shake up the status quo a bit.

Meta opening up its VR OS to become the "Android of VR" feels like one of those moments - moving away from the Apple-like closed ecosystem to multiple third party devices focused on different things. This could expand the market and create some interesting opportunities.

We haven't made a VR investment yet, despite me being an early enthusiast, because VR has consistently failed to meet the expectations needed to underwrite a venture-scale growth trajectory. But I might re-evaluate that in light of what comes out of these changes.

I’d contrast that with Apple's Vision Pro, which in its current state looks somewhat DOA from a developer ecosystem perspective. Never count Apple out, but there’s a lot of work to be done there.

What is the likely impact of AI on game development?

AI could turn 10X developers into 100X developers. There's certainly an opportunity for startups to counter-position against big incumbents: the Activision-Blizzards of the world will be more reluctant to embrace AI aggressively due to unresolved legal and copyright issues, while a startup can embrace those tools to make games at a fraction of a big company's cost. It’s still unclear if it’s a source of sustainable competitive advantage vs a tool everyone uses to be more productive.

That said, I am bullish on startup studios aggressively embracing AI to more quickly establish some other sustainable competitive advantage such as a network effect. The value isn't necessarily in AI itself - it’s just helping you build a moat faster.

As for whether AI will enable entirely new forms of gameplay, I’m reluctant to get too far ahead of myself. I remember Microsoft hyping cloud for Xbox, saying it would enable entirely new kinds of games. We're still waiting for an example of what that unlocked gameplay-wise.

How to identify sources of distribution advantage

Finding distribution advantage is really hard, and is sometimes driven by developments outside your control. I wrote recently digging into Valve and the conditions enabling them to build Steam. Those windows don't stay open indefinitely.

If I had to pick where to fish for opportunity now, it might be the web. Developments in browser processing power and fidelity could open up new viral distribution possibilities for rich experiences. I'd also watch platforms like Discord for interesting opportunities. The intersection of live video and gaming is also interesting and under-hyped.

Another approach to consider is not just focusing on pure distribution, but also identifying overlooked audiences. My friend Bertrand Vernizeau shared a memorable anecdote about being pitched by the developers of Power Wash Simulator. They presented Google Trends data showing a significant number of people who were passionate about power washing but had no games catering to their interest.

In some ways, Riot's initial strategy for League of Legends followed a similar path. A core part of both their product and distribution strategy was to consolidate the fragmented audience that had originally formed around DOTA.

When developing your strategy, consider underserved audiences, where they hang out, and how to reach them cost-effectively. However, it's crucial to have a plan to establish a strong competitive position based on that initial distribution advantage. Otherwise, as Mitch Lasky has pointed out, the advantage will simply be arbitraged away.

What effect has everything we’ve discussed had on the way you invest and build a portfolio?

We make two kinds of investment.

At pre-seed, our investing is done exclusively through a program called Co-Pilot. We roll up our sleeves and work closely with the entrepreneur on their plan for the company, help them with their pitch, and create a roadshow for their fundraising process when the time is right. In exchange, we get a compelling entry price, lower than typical pre-seed valuations.

This allows us to use our entrepreneurial experience to influence their early trajectory and earn a good equity position. An advantage of this approach is that gives us the opportunity to get to know people outside of a typical fundraising cycle. It's a way to develop stronger conviction through a direct working relationship with founders.

At seed, we invest on market terms, and we are happy to pay up if there's strong evidence of product-market fit and traction we can evaluate.

We don't want to do anything in between. Having that clarity helps us focus on what's relevant for us out of the 1200+ companies we see a year.