SBJ/20090126/SBJ In-Depth

The venture capital well runs dry

Matthew Bromberg, the outspoken president and chief executive of Major League Gaming, is typically blunt about his recent dealings with Oak Investment Partners. The venture capital outfit recently supplied the competitive video gaming league with $7.5 million in funding, pushing the league’s total investment to $42.5 million.

“It was definitely a big relief, and we didn’t even necessarily need the money,” Bromberg said of Oak, a longtime backer of Major League Gaming. The new investment will help fund further expansions of league operations. “But it’s an absolutely brutal environment to be raising money right now, and we were very fortunate to not have to make another phone call [to another venture capital outfit].”

Major League Gaming’s anecdote represents only part of the venture capital story as it relates to sports, particularly entities with a heavy digital media focus. The league is established, has ably survived the demise of most of its direct competitors, and boasts a viable business plan buttressed by relationships with ESPN, Dr Pepper, Hewlett Packard and other corporate heavyweights.

For thousands of smaller, upstart operations and entrepreneurs yet to form a full semblance of a company, however, the story is very different. Even before last year’s collapse of the commercial banking industry and the deepening recession, digital media startups frequently relied on private venture capital outfits for funding to launch their businesses.

But those venture capital operators — by definition more long-term focused with their money and less risk-averse than a typical bank — have now also winnowed their spending considerably.

Major League Gaming has been among the fortunate
sports entities to land venture capital.

Venture capital investment in all American companies fell 8 percent in 2008 to $28.8 billion, from $31.4 billion the year prior, according to Dow Jones VentureSource, with the total deal count similarly falling from 2,823 in 2007 to 2,550 last year. Information technology investments of all types in particular took a 15 percent fall during 2008 to $11.6 billion.

Liquidity at the back end of the venture capital cycle also plummeted in 2008, as venture-backed companies regardless of industry sector generated $24.1 billion through either initial public offerings, mergers or acquisitions, according to VentureSource, down 58 percent from $57.6 billion in 2007.

The same trends are all at play specifically within digital sports media, industry executive say.

“This economy has caused everybody to take a big step back and really recheck their existing portfolios,” said Brian Grey, executive-in-residence for Polaris Venture Partners. The former head of and Yahoo! Sports joined the venture capital firm last summer. “And it’s definitely fair to say the bar [for new deals] has gone up.”

The funding well has not run completely dry, though. New investments are still being made (see story). But the criteria used to evaluate those companies has stiffened up, with funds now generally reserved for companies with more mature business plans that are already showing evidence of sustained revenue and audience growth.

“The capital is definitely more constrained and it’s much harder to raise funds, but there’s also far less competition for that money,” said Josh Swartz, chief operating officer for Wasserman Media Group, whose properties include Sportnet, an aggregator of sites devoted to action and Olympic sports. “It means fewer deals getting done now, but the ones that are getting done are better ones, and that’s definitely good for the entire industry.”

New criteria

Even amid the current economic slowdown, venture capital firms funding new entrants in digital sports media are looking for a few critical elements: an innovative product or service that isn’t replicated elsewhere, particularly among the mainstream national sports sites such as and Yahoo! Sports; a fleshed-out business plan that will generate sustaining revenue, typically within a year of launching the business; and a distinct level of passion about sports.

Within that evaluative framework, the fiscal belt-tightening has manifested itself in two key ways. The first is a heightened emphasis on existing relationships in which venture capital firms are now much more hesitant to invest in someone unknown and instead prefer to make their bets on someone who’s already proven themselves elsewhere.

“It’s always been about investing in talented, top-quality individuals for us,” said John Kosner, senior vice president and general manager. The company has made nine digital media-related acquisitions in the last three years, including funding rounds for “We see that as a seminal part of being successful.”

The second is a near-universal demand for a diversified revenue model that does not put all its eggs in either an advertising-based model or a subscription-based one.

The reasoning on the latter is fairly simple. The ad market has plummeted for established media entities of all types, making the marketing pitch from an unknown startup that much more difficult. Premium content-based operations, meanwhile, typically find it difficult to generate meaningful scale because so much sports information and sports-related social media have become basic commodities online.

“In a market like this, ad dollars are the first to go, so wrapping an idea around just that is going to be real tough [to generate funding], but the subscription model can’t carry an entire company, either,” said Brent Jones, former San Francisco 49er and now managing director of Northgate Capital, a Silicon Valley venture capital firm. The company has invested in Citizen Sports Network, while Jones has invested privately in SB Nation, a blog network chaired by former AOL executive Jim Bankoff.

“There’s too much free information out there,” Jones said. “So you have to have some balance. But the bigger question to me is how you create the next generation of passionate fans. That’s the sort of thing I’m looking out for.”

Downward pressure

In this new economy, valuations ascribed to companies in venture capital investments are also down considerably. Deals that might have gone for $8 million to $10 million are now down in the $5 million range, $5 million deals are down in the $2 million to $3 million range, and so on.

But those dropping values also have venture capital outfits looking to seize an opportunity to buy into new companies at relatively cheap levels.

“There’s definitely buying opportunities out there. We see 2009 as a year with still a lot of upside,” said Doug Perlman, general partner of Accrue Sports & Entertainment. The former NHL executive last year joined the firm whose partners also include Bryant McBride and Steve Solomon, both of whom were involved in the formation of Fan Nation and Scouts Inc. before they were sold to Sports Illustrated and ESPN, respectively.

“The general conversation is obviously a little different now given the pressure on valuations. That’s the marketplace talking. But you want to be perceived as entrepreneur-friendly, so we’re out there and we’re seeing deal flow in early-stage companies,” Perlman said.

There’s much more to the story here than a vulture play on distressed companies looking for funding. While no one knows for certain when the recession will be over, the unofficial consensus is that by mid-to-late 2010 or 2011, conditions will be different.

And by that point, publicly traded companies will likely be under rising shareholder pressure to show growth again. Among the simplest ways to do that will be to buy companies currently being founded on the backs of venture capital.

“I’m still very long-term bullish on this space. All the trends we’re seeing in terms of content and activity moving from offline to online have not abated, even with the economy,” Grey said. “So you have to go in with that orientation. Early-stage companies, for example, are probably not going to pay off for three to five years. But with costs pretty reasonable, this can be a very good time to invest.”

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