What does it take to stand out and succeed as a games industry entrepreneur these days? And how should smart venture capitalists best identify and work with these best founders? To help answer these questions, host Aaron Bush is joined by David Kaye, serial entrepreneur and general partner of F4 Fund

We discuss why David believes 99% of games studios aren’t fit for venture capital and what makes that top 1% so special. We also cover how early-stage teams, especially in a post-cheap money era, can get scrappy, think about distribution cleverly, and unlock early forms of competitive advantage. Plus, alongside discussing the state of gaming venture capital at large, we also dig into what David sees as underrated and how that’s reflected in the way F4 builds its portfolio. Buckle in for a thought-provoking conversation.

If you’re interested in learning more from David, make sure to subscribe to his newsletter: https://blog.davidkaye.co/

We’d also like to thank Overwolf for making this episode possible! Whether you're a gamer, creator, or game studio, Overwolf is the ultimate destination for integrating UGC in games! You can check out all Overwolf has to offer at https://www.overwolf.com/.

This transcript is machine-generated, and we apologize for any errors.

Aaron: Hi everyone, I'm your host Aaron Bush, and today I am excited to chat with David Kaye. David is a long time games industry entrepreneur, who more recently became a venture capitalist as the co-founder and general partner of F4 Fund.

As such, nothing said here today is financial or investment advice. But I wanted to have him on because I find his views on building and investing in gaming startups to be uniquely refreshing and thoughtful. Now, if you heard David previously on our roundtable episodes or have read any of his essays on Substack, you probably have come to appreciate his honest takes for what works and doesn't work when investing in gaming, how startups can stand out and outperform in today's environment.

And what the future has in store for our industry. We will dive into all of that today, but without further ado. David, welcome back to the Naavik Gaming Podcast.

David: Thanks, Aaron. Happy to be here.

Aaron: So as I mentioned, we got a bunch of topics to dive into today, but really where we should start is just setting the scene.

And the best place to begin there is just to learn a bit more about you. So first, could you just quickly run us through your career as a game maker and a games industry entrepreneur?

David: Sure. I'm going to give you the very, the 32nd version. It's been About 25 years as an entrepreneur in games started out making text based online role playing games.

Since then I've helped to build companies doing social games was an advice to some of the early mobile game companies. And then most recently built a more PC and console focused studio called Snapshot Games that was acquired by Embracer in 2020 and started the fund January of last year.

Aaron: And if I'm not mistaken, your first company you started when you were in high school. What was that experience like for you and shaping your trajectory and just like what you learned as a high school entrepreneur, because that's super unique.

David: It was tr yeah, it was transformative. I, it came from, I, I got kind of addicted to, uh, a, a mud called Avalon. This is in, when I was like 13 and this is pre internet actually, they had a bunch of modems you could dial into and they had some really grotty offices in Camden that we'd go, my friends and I would go there on the weekends. And that was my first introduction to like multiplayer, to online gaming, pre internet.

And then I sort of came back to it. I was just curious, checked in on it. Obviously it went on the internet a few years later and I met my first business partner, Matt Mahaley. On that game and we got to know each other and he's like, Hey, I want to make a game. And I was like, Oh, cool. That sounds like more fun than doing my homework.

And that was that was, yeah, that was the start of everything. In fact, actually one of the founders of Avalon, it's a guy called Daniel James, who is, has been an also a games entrepreneur, his whole career is based here in San Francisco. And his it's actually an LP in our funds.

He's like the person I've known him now for God, 30 plus years. Yeah. Shout out to Dan for starting me down this this slippery slope.

Aaron: No, that's amazing. And now you, as a venture capitalist, get to look for the next David Gayes, who are out there building quirky shops.

David: I want to find the people who are much more successful than David, than me.

Aaron: Don't sell yourself short there, but understood. Let's go ahead and shift gears. How did you move into the investing and venture side of things? Like when did you first get that investing itch and realize this would be a good next phase for your career?

David: Years before this I've done, the only other thing I've done aside from starting game companies really is I also started this community that became a company called Gaming Insiders and we ended up, it was a start as a mailing list for founders in the games business and grew into more of a media and events company.

But the part of it I really enjoyed the most was spending time with I got to meet so many great entrepreneurs, some of whom are, still friends and colleagues today, and so I think what my one regret was, man, I, if I had a fund and then to, cause I was I had a pretty good eye for talent.

And that was always at the back of my mind. And then I knew after snapshot was acquired, I knew I didn't really want to start another game company. And so circled background to this idea and got some encouragement from some friends who became LPs. And that was kind of the beginning.

Aaron: And so now you have. And maybe you could tell us a bit about it. Like, how did that come together? What is your focus? Who's the team? Just whatever context you think is most relevant and helpful.

David: Sure. So F4 is a pre seed and seed stage fund that invests in. The future of media, or really it's the future of media and communications, and I don't think we need to spend too long on like the thesis, but I my, my perception was I really wanted I, I obviously coming from games and my partner also comes from games. Clearly that's an area of interest for us, but I think the thing that's interesting about games is it's really always been of all the content industries.

The first to adopt new technology, new distribution models. And so I think if you spend a lot of time in games, it really and I've always been really interested in media in the broadest possible sense from, building stuff on the early days of Facebook to just tracking the development of streaming and how all those worlds are increasingly.

Technology driven and colliding in all kinds of interesting ways. And I just want us to be in the center of it.

Aaron: Nice. And maybe you could just share a bit more about what kind of companies have you invested in so far? I think you got, you made your first investment about a year ago, but how was this first year shaped up for you?

And helping you create your strategy and, just help like narrow in on the types of businesses that are the best fit for your fund.

David: Yeah. It's been a really interesting first year. We've learned a lot. As far as the kinds of investments that we've made, I would say about a further portfolio is in games.

Beyond outside of games, it's it's really a mixture of, we have a little bit in kind of consumer and social. We invested in a dating app called. Called Blush. We are we also are a seed investor in a, the kind of loyalty and cash back business called Benjamin that, that has a, also has a strong gaming dimension for helping publishers to acquire users using some very unique data that they're able to get access to.

That investment is doing incredibly well. So we're it's been great. We've been, I think we've been, we've also, the year has been also about learning, sounds really bad to say as a VC but learning how to invest , yeah, how to play the game a little bit.

I wouldn't put it that way. Cause I makes it. I don't know if that makes it sound worse than it is, but I, in some ways, but it's more been thinking about in the same way that, as an entrepreneur, your job is to figure out what you can uniquely bring into the world that is necessary, that is needed.

I think as the great investors also have a very strong sense of what they're about and what they bring. They can uniquely bring and they can express that both through the ways that they work with companies and actually how they structure their investments as well. And so I would say that at the outset, I was.

 I did some angel investing prior to this and yeah, as an angel, you can just be pretty much, you can be pretty simplistic about it. Like, Oh, I like this founder. I like this idea. So yeah, I'm going to put some money behind it, but I think as a VC, be a lot more.

David: Disciplined and structured. And I think that's been a real learning process, but I feel really good about the progress that we've made in the year that we've been doing it.

Aaron: Nice. Any other big learnings for the year?

David: Again, sticking with the sort of the investing side, I think. It comes down to just discipline around things. Things that could be, you might, this might be a really interesting company, a great entrepreneur, but it may or may not be a good investment depending on all sorts of things. Yeah, like your entry price and so I think it's yeah I go, I wrote a piece a little while ago about, about, about what I learned in that first year. And I think a big learn, a big takeaway is also learning. Look, we're a small fund, right? We're a 10 million fund. And that means there are things that we can't do that that, that the big funds can, but at the same time, there's a lot of things, there's a lot of areas where we can play and that are just don't make sense for a big fund because they have so much more capital to deploy.

So in some ways, like I don't. I don't envy the huge funds just looking at the kind of returns they have to, that that they're looking for on the amount of capital that they have. It's not an easy job. So I think learning more about how our size can be a, a real advantage in some ways is, has been eyeopening.

Aaron: Nice. I'm sure we could talk about learnings much more. Maybe we'll get to some more later, but let's go ahead and zoom out a bit. Part of why I wanted to have this conversation as I, I mentioned in the intro is because you've had some like pretty interesting unique and thoughtful takes about investing in the games industry.

Some might dare to call them spicy. And for example, maybe a year ago when you were starting to invest out of F4 you were talking about how 99 percent of games studios should not raise venture capital. And I think, at the time, maybe there were some grumblings about that.

Today, it's become As we were talking about before we even hit record, that seems to become a bit more accepted and you know what other investors and industry at large thinks about. But even so that's a pretty striking comment to make given that companies making the content are the vast majority of the games industry and drive, a huge percentage of the entire revenue for the industry.

 I'd love for you to break that down more. Why are 99 percent of, game studios not fit for venture capital?

David: First, I'm going to give a little caveat, which is that I'm giving it from the perspective of a VC in terms of like how I think about deploying capital. If I take off my VC hat and I put on an entrepreneur hat I think the thing to note is A, not everyone agrees with me, and B your responsibility is, as a founder, is like, get money if there's funds out there that are dedicated pools of capital to deploy go after that money 100%.

So like that I'll, all right, I'll take that hat off and put the VC hat back on. And I think it comes down to a few things. I think you just have to understand what venture, Capital is right. And the core issue I think is that VC is an asset class that is really best suited to industries that can deliver and companies that can deliver very high velocity growth.

And I think looking at the gaming sector. It really only does this periodically. And that's usually in the wake of some sort of platform shift driven market expansion, mobile being obviously the most recent and the largest in that, in that, in, in history, really outside of those periods, it's historically been quite hard.

To deliver venture scale returns. And if you look at the vast majority of venture scale outcomes that have come, in the last few years, it's all come from mobile, which was companies building that were in the right place at the right time, executed really well and created a ton of value and mobile was actually.

Especially pre ATT was uniquely well positioned to deliver that kind of growth because you could build a game relatively cheaply and then if it worked, you could pour huge amounts of money into scaling it which you can actually still well, you can't really build super cheaply anymore, but you still can pour lots of money into scaling, but there's a whole bunch of reasons why I think it's much harder to do that.

That's a much harder game for startups to play relative to big companies like, like Scopely. And I think like looking at the game studio, the, the game studio thing specifically, I think a lot of the most durable competitive advantages of studios. Are actually built over time and you know the taking a long time is somewhat is pretty antithetical to the like to what VCs want you to do right that's hurts their returns and so you know you look at some of the big success stories especially when you look at the sort of the.

The the PC space that a lot of funds have more recently pivoted into a lot of the studios that everyone, the games that everyone, really respects and loves, you know, companies like Larian and from software and, companies like this, these have all. Their advantages have been built over long periods of time.

They've built a reputation, they've built a studio brand. They've built a kind of an understanding in the audience that cultivated an audience for the kinds of games that they make specifically. They've been able to build internal teams. They've been able to build resources, tools and the sort of culture of working together and making the, getting really good at making the kinds of games that they make.

And none of that is easy is easy to do quickly.

Aaron: Yeah, and obviously there's a huge difference between trying to pitch a game versus pitch a company that have so many more elements to it. But I guess it leads me to. My followup, which is, if 99 percent of those companies shouldn't like, what are the traits and characteristics of the 1 percent that should like what do you see as making those teams special where they kind of rise above the rest and are more deserving?

David: Yeah. So I think I'll give a very practical numbers based answer and then maybe a sort of a broader one. I think the short answer is. And like we're a seed, you know, we invest at pre seed and seed. So I'd say, first of all, if you think you can sell your company for at least 25 times your seed valuation within, seven to 10 years, then think about doing venture capital.

 And specifically have a really good answers for what elements of your plan and the market make you think that this sort of return, this sort of growth profile is plausible. And I think also you should need to also be honest that like with yourself about, do you actually want to do this in this way?

Because there are many game developers. I've just been talking about that probably would love to do this for as long as humanly possible. They don't really want to put themselves on some sort of trajectory where they're looking to be, exit to a strategic admister or to IPO or something like that.

So I think the first thing is like what do you actually, what do you want to sign up for? And if it's not some version of that, then I think it's probably wise to investigate. Other options, whether that's, bootstrapping, working with publishers, crowdfunding, working with angel investors, things like this.

I would say that the companies that are the best fit for venture are ones that could ultimately. Become something larger than a single game company or at least can build that game into a platform of some kind that procreates an opportunity to have a more uncapped return profile, because really what a VC is looking for is a plausible Scenario in which you could be worth hundreds of millions or ideally billions of dollars, and that's not going to come from, Hey, we built a really cool game and put it on steam.

Aaron: Yeah, and also much easier said than done, especially when you haven't, I guess it's tough to pitch being a platform when you're still at a pre seed stage, like how do you think through, those kinds of pitches and opportunities that come along to separate it. What is real and has potential versus, what is mostly talk.

David: You're right. You can't pick, you can't come out of the gates. There's a lot of companies that do obviously try and build platforms, right out the gate. And that's typically very challenging. I do think that, looking at gaming, like just focusing on companies that are actually building games.

I do think it is actually quite reasonable to. Expect that we will see more games that so if Roblox is a horizontal world, like a horizontal UGC platform I think it's plausible to imagine. And we have already seen some of these, a number of games becoming more vertical worlds.

So there is actually a game and an audience there to begin with, but the game is really built from the ground up to eventually become a place where the players, some proportion of the audience can participate in creating on that platform and in that game. And I think it's reasonable to have that in your platform.

Yeah, in your plan at the earliest stages, even if you are making clear that the sequencing is going to be, that's going to probably happen a bit down the road.

Aaron: Yeah, maybe you can break that down slightly more for us. What exactly do you mean by vertical? Is it just that users can build on your game or is it a Or is there more to it than that?

Also, you wrote about this on your sub stack and we've talked about it a few times, so feel free to, tell people where they can find.

David: Yeah, no I did. I wrote a piece about, I think that's where I coined this term vertical world, but for example you can imagine. A a shooter, for instance, like you're and you're with the comes out with a set of modding tools.

You're not going to use it to go and create a platform game completely outside both the genre or the or the theme of the game. But it might come with a set of tools that allow you to create different kinds of shooter experiences or levels or missions or stories or what, or all kinds of different things within that universe.

So that the, look, we've seen this, there are examples of this happening. Skyrim is this really in a way, it. That's people more creating additional content for the game. But I think more of those can thrive than I think there's going to be a hard, there's a hard limit on the number of the horizontal sort of everything platforms that, that are, that, that can achieve any kind of scale.

Whereas I think there's a room for quite a lot of winners potentially in the, if they're taking a more vertical approach.

Aaron: Yeah, I think that's fair. Even just when you look at kind of the growth in the. The modern day modding community and, seeing kind of the rise of premium mods now, private servers, all of that kind of stuff.

What you're saying makes sense in many forms. So that'll be interesting to see how that plays out. So if most gaming companies shouldn't raise venture capital and there are the 1 percent that really stand out, I assume are like the more competitive deals. And then there's the rest, some of which still, end up raising money in some way.

That has an impact on the valuations that companies have influencing, just like the state of how investors must think about the market. You recently wrote a piece about why gaming valuations are too high. Maybe you can tie this all together for us,.

Why that is and break this down in a bit more detail for the audience.

David: Sure. So I really have one main job as a, as an investor. And that is to deliver really good returns to my investors, the limited partners who are invested in our fund. And the other day that's driven by a fairly simple.

Calculus, it's how much are we paying for the stock that we're buying and how much are we able to sell that for on exit? And I think when I said that I, what I think early stage, some of this, especially the precede gaming valuations are too high. Really what I meant was I did not, I feel like we see a lot of deals where we do not feel we are being adequately compensated for the amount of risk that we are taking at that stage.

And, and I, the reason I say that is because as we, because we are not just a gaming fund we invest across media communications, we see a lot of companies, a lot of different areas. And it's really striking. I can get any specific and some numbers as we, GDC was not all that long ago.

It's still not uncommon to see game pitches for from game companies where they are looking for a valuation of anywhere from 10 some cases at a very early stage, often. There's just a pitch deck or maybe something very rudimentary, but really not very de risked. And. At all and there's also quite a lot of capital is going to be needed and this is just a part of it is that's the nature of games to eat to de risk the investment in any way whatsoever.

And so for me as a GP, I'm looking at that and then I look at other deals that we've done where we can see a company. In that it's maybe a more technology company and in doing something in the media space and they've built a version one product already they maybe already have a few hundred thousand dollars in your annual recurring revenue it's growing you know 30 percent month for month and they're raising it you know ten million dollar.

Post money valuation, or, as the seed, some of the seed where our recent seed investment we did, which had just, was, I think it, we invested in a, in the high twenties, but they were already had multiple millions in ARR. And it just, when you put those deals alongside the, Hey, here's my cool game idea pitch deck, it just feels irresponsible to deploy too much into the latter.

Aaron: Yeah I think that's, that's fair. And of course the, everything changes all the time. Where we are now is different from where we were a year or two ago, and I imagine a year or two from now it will continue to evolve. So there's always this, give and take this push and pull between all the parties that play it, where this ultimately, lands across an entire industry and how it evolves, another piece of this.

David: I have one very experienced investor. I know who they do some gaming, but they do a lot of other stuff to his perspective is that in a year or two, it will be a great time to be investing in games because you're going to see a lot of teams that have raised like large amounts of money and failed.

And I'm now like battle tested entrepreneurs and now and who are going to want to build things in a very different way the next time it's just quite dark but interesting perspective.

Aaron: I think that's true and you know another way to think about that now is like you know that means today, like there are companies struggling that have raised money at higher valuations than they should have in the past and are trying to like work through really difficult times trying to find solutions of where to go next.

And not all of those companies, most of them don't really find that solution, unfortunately. And they become the investor or the founders that you're talking about, but, There's also the opportunity for other types of investors in the space. When some of these challenges arrive to step in, whether it's private equity or something else.

So it's interesting to see how the whole. Ecosystem evolves and forms around all of the opportunities and challenges that are constantly in flux. But another piece of this equation and that affects valuations is, maybe it has to do with interest rates. Maybe it has to do with like market sentiment as a whole, but it really revolves around this idea that.

A couple of years ago we were in an era of pretty cheap money valuations were high, and when valuations are high, it's easier to raise money using your equity, because you give up less to get more. If interest rates are lower, you could even raise debt, which, many, maybe many not startups are doing that, there is venture debt, but however you look at it money was easier to get but today, it's a lot harder to get, which means that There are more conversations like the ones, we're having right now, or that I'm sure you have with founders about, some of these valuations are too high, they probably should be less.

But if they're less, then that also means that what they're raising might be less. The way they have to think about building their businesses from ground zero is a little different than maybe it was, a few years ago. Could you, maybe walk us through some of your thinking around this phenomenon.

If the era of cheap money is over, how does that mean, entrepreneurs today need to get scrappier? What does that look like in the games industry? Curious to hear your thoughts.

David: It's interesting. The last, the most recent games investment we made which was a pre seed deal through our, we have a program called Copilot where we work very closely with founders and get much more involved than we would on a sort of traditional investment.

And it was I think he's quite a good example of. The type of person that we're interested in backing, which is solo dev. I think he now has one person helping with art, but he was the only artist also for the past like year. He based in a a geo that is not San Francisco, LA, New York not a high cost geo and a little bit further out there and is building.

Very, quite slowly, something that has potentially really huge audience at the other end of it. But is, he's a, yeah, one of these 10X genius solo devs who, had been in the industry for a very long time, and it's just been building this thing. And so I think what I would I would link back to is like building in sort of cheap geographies building a much more systemic than content driven game.

 A game that is not dependent on law on working your way through large amounts of developer created content. So for example, a great example of I had very heavily caught like well, let's go three. It is actually both. It's heavily systemic, but it is also incredibly heavily content driven.

David: You, there's no way to make that game without, just a ton of people. Basically, yeah. Yeah. So whereas a more systemic game would be Minecraft, for example. So more systemically oriented games. I think also I have a kind of a word I've been, a concept I've been trying to make happen from, again, from my, my, my substack is, ooh, let's hear minimum.

Minimum viable fidelity, which is, I think you see this particularly people coming out of more sort of AAA high fidelity game production backgrounds is they haven't, they tend to set a very high bar for what's what they want to, what they want their game to be, to look like. And I think that most of the time people shoot too high.

And if. If you look at some of the big success stories that we've seen, like it's, it, people will tolerate much shittier graphics than you than you might expect. And uh, and I think really And I think this also comes back to the point of like, why, why most game developers are not always the best fit for venture.

It's the distinction between building the game you've always dreamt of building that's the biggest best version of whatever is yours to build versus building a company that can really thrive and one of the ways to do that is, keep the scope, be really ruthless about the scope, really embrace this idea of minimum viable fidelity and that might not be, that might mean that what you have to work on first is in conflict with the ideal game that you would make in under the best possible circumstances.

Aaron: So another potential piece of this is another buzzword that everyone is talking about AI, which, potentially for good reasons, right? Like it could be part of the tooling for these teams and entrepreneurs to get more efficient and be part of the solution in this. Post cheap money era and it's a technology that naturally startups should have an advantage in but I'm curious, David, how are you seeing startups you're talking to deploying AI and new and interesting ways that others could learn from, or, if some of that is too proprietary, maybe we could even just take it in a direction of like, how do you think this technology might provide startups an advantage?

Over legacy incumbents and make a lot of what you're saying about, being scrappy as entrepreneurs more viable.

David: So I think there is definitely some at least sort of short term counter positioning opportunity available to startups. And by that, think that. The large, your sort of Activision blizzards of the world are are going to be more reluctant because there's, a lot of outstanding unresolved issues around legal and copyright.

And as a startup, you're probably more, more inclined to just be like yeah, whatever, let people with much larger, much larger budgets worry about it. So you could, there's an argument that you could say. You'll, they'll embrace these tools much more aggressively. I do think that it is going to mean even, some of these 10X developers that I've been talking about, maybe become a hundred X developers actually because they can just do things before that with these tools that were just impossible previously.

And so I think like that, that we. We will see, I think actually that really is like the area of the market. It's just most exciting to me because you just making it possible for these small teams to do huge stuff. As far as I think where I'm still figuring out is to what extent any of this is actually a source of sustainable competitive advantage, as opposed to just a tool that everyone uses in the same way that, People use better software all the time and it helps them be more productive.

I, we do have one investment in the portfolio. It's actually our first investment was series, a series AI that really they are, there are AI native game studio and they're, They've embraced a lot of these tools very aggressively in a building have really been also building a lot of stuff, that's proprietary internally.

And so I think there may be some companies that just push the envelope as far as what can actually be done with this in terms of what kinds of games can you now make that were not possible before. A little bit reluctant to get too far ahead of my like I, cause I find that often.

I can't remember if you remember like back when, um, Microsoft was pushing the last Xbox, they're making a big deal about cloud and the cloud was going to cloud native console and there were kinds of games that you could just never even imagine because there'll be like hybrid cloud native things.

And I think we're still waiting to see, one example of what all this cloud, this super amazing cloud technology and infrastructure enabled from a gameplay perspective. So I think I'm similarly and we do have a studio and we do have another studio that's unannounced investment.

That's. A really great developer that's also doing some interesting things with a little AI and gameplay and agents and that sort of thing. But, it's hard enough to make a really fun, new kind of gameplay using, just tried and tested predictable tools. And AI is like the opposite of that.

It's so many of these technologies are just like fundamentally non deterministic, which makes them even more difficult to work with in a game, because games tend to be about systems that perform, in somewhat predictable ways. So I, I'm not holding my breath for the next crazy big new genre, but hey, I'd love to see it and I'd love, I hope we invest in it.

Aaron: Yeah, I don't know what that'll look like either. I have similar hesitations, just because AI doesn't replace creativity. It can make things more efficient, but at the end of the day, it's not the brains behind like entirely new and interesting ideas. But maybe one day it will be, but that seems pretty, pretty far out there.

But, I guess I would push back a little bit in saying I do think that there will be pretty strong relative advantage for those that do and don't adopt these tools, and I think in the same way, it's probably easy to overplay how transformative a lot of this technology is in the near term. I think it's also, it's definitely, Easy to underplay just how slow and lethargic the biggest publishers making the biggest games are going to be adopting these tools.

Not just because they're big and slow and need legal approval for everything, but working with big IPs, I've just been able to pick up you can't even touch, any form of AI tooling, generally, if you're working with the biggest IPs also. Just a lot of these large companies, AI tooling, is a lot of employees view it as a threat instead of an opportunity.

And so it becomes like a cultural issue. And, just imagine trying to adopt these tools while working with a union, if you're again, like Microsoft in some way, in certain parts of their business that's going to be enormously challenging and it's going to enable some companies just to move way faster and as a startup, speed is often the best.

Advantage you really have and I think that's going to shine really brightly with these AI tools. Do you agree with that?

David: I do agree with you. I think that the thing that kind of maybe the footnote I would add to my original comment is I think I see that the tools as I think it's going to be about are you able to use these tools?

To help you more quickly and efficiently establish some other form of sustainable competitive advantage. And to the extent that you're able to do that that you're able to use them to do that, then yes, you can create huge value, but the value it's not necessarily going to come from the AI stuff itself.

Aaron: Yeah. Another, term that's been thrown out a lot lately is distribution. And, the idea of distribution advantages which, that's not new either distribution advantages have been fundamental to gaming and basically every industry ever. For as long as business has been a thing.

And you can look across all sorts of big waves. Like you mentioned mobile as a form of, unlocking a distribution advantage or a new form of distribution that really was a rising tide for a lot of industry, for a lot of companies that were able to unlock value by doing that. I found that the concept of distribution, unlocking new, unique distribution.

That gets talked about a lot more in industries that become more stagnant or slower growing. And so it's not a surprise to see the industry have more of this conversation lately. Because it's harder to come by. It's harder to unlock, entirely new forms of distribution advantages, but it still is really important.

Especially when you're building new companies, because the whole idea of, if you build it, they will come that almost always doesn't work. And you, if you want to stand out above the rest, you have to be thoughtful about distribution. Um, beyond me sitting to obvious, I'm curious, like how you think about that from, looking at these companies, like what types of distribution levers and advantages are you finding?

Are you seeing entrepreneurs pitching today or that you wish they were pitching more today? How do you think about this right now?

David: The first of the first thing to note is like finding distribution advantage. It's like really hard. And sometimes it's driven by developments that are outside of your control to a degree, right?

When I wrote an article recently, I really digging into. history of steam and looking at what it was, what was possible, what were the conditions that made it possible for valve to make the strategic move that they did? And there were things that, the, at that point in time all came together.

To make it possible for valve to build steam. And those windows don't always open. They're not open indefinitely. So part of it, and it's a good question. Like what windows are open or are opening, now, or are open now. That will unlock new potential sources of distribution advantage.

If I was going to say like, where would I be fishing? Where do I think is an interesting place to be fishing right now? It might be the web. Because the developments that have happened in terms of what kind of process, what sort of processing power is available in just the average computer that someone owns combined with.

Technologies that make it much, much allow you to deliver experiences that really high fidelity and and beautiful and interactive in the browser that could create some interesting, that could create some interesting opportunities, right? You can have something that goes viral and people can share it all of a sudden, a million people have.

Have played your game in, in, in a handful of days. I remember some of that from the early days of, you know, Facebook. It might also be that, I would also keep an eye on software platforms like discord, there, there might be some interesting opportunities there.

So I think that's one, one thing. And then. I think the other, as far as like game developers go, game development goes, I think the other, another way of thinking about distribution, it's not really distribution advantage exactly, but it's very closely related, which is it's finding pockets of.

Audience that are overlooked and tapping and thinking, how do I reach them and how do I tap into them? And we have a portfolio company that is doing this, has a very interesting approach to this, but that I won't talk about, I won't talk about, but I will share a story. I remember from my friend Bertrand Vernisseau, who's a really interesting guy who is He's not a VC, they invest in a lot of sort of premium Steam games, but has a very independent mindset.

And he talks about getting pitched by the developers of Powerwash Simulator, which, is a surprisingly large or I guess not surprisingly large when I finish the story. Yeah, game and IP and he remembered the pitch and the guy basically was like pulling up Google Trends. Look how many people are just obsessed with power washing.

Basically I'm butchering. This is like a third hand retelling of the story, but that was like a, that was just a really interesting example of an audience insight that was like, okay, there were not, there's a million people trying to make the next, MOBO or whatever, and oh no, there's not, but there's zero games about power washing, and yet there's loads of people that are really interested in power washing, and we think we can build something for them, and that is a, an audience in some ways, you could look at in some ways, you could look at the story of riot games as being a little bit of that as well.

There was a sort of observation that that Dota 2 was, I'm sorry, not Dota 2, but the original Dota mod was this massive audience that was fragmented across all these different games. And really their strategy was, we're going to, we're going to roll them all up. And it was part of their, so it was part of their distribution strategy was part of their product strategy.

And so I think thinking always about audience and where, who are these audiences that are underserved that are maybe not, and where do they hang out, where can I reach them, cheaply that's also, I think, closely related to this idea. And then. You obviously have to have a plan that allows you to then build some a strong, competitive position off the back of that distribution advantage that you've identified.

Otherwise it gets, Mitch Lasky talks a lot about this, otherwise it just will get arbitraged away. And so, um, that's the, that's the other piece of it.

Aaron: Yeah, you also wrote a good piece about the seven powers and how it applies to gaming companies, especially at the early stages, and I feel like a lot of these conversations that we've been having, around getting scrappy AI, unique forms of competitive advantage, it all kind of ties into this, so maybe you could share briefly what the seven powers idea is, and then which ones apply to gaming founders in interesting ways.

David: So the step seven powers is it's from a book by a guy called Hamill Hamilton Helmer, and it's really a framework for thinking about where sustained where moats come from. It's a sort of taxonomy of different kinds of moats. And. The reason that these moats are important is most businesses.

It's a, there's a main point I make in this article is that, we were encouraged to think about competition as being, part of your job as an entrepreneur is to compete really effectively. And if you're really good at competing, then you can win and build a valuable company.

But the sort of the more accurate way to think about competition is that the most valuable companies have found ways to escape competition. They're not competing on a level playing field with everyone else. And because if you're competing, the more competitors you have the more likely it is that you are going to be forced to, your prices are, your profits are going to be driven down, but because there's just so many other places that people can get a comparable product or service or experience from.

And The Seven Powers are basically, it's basically a list of these different forms that this, that these motes can take, and They are, they're scale economies, network effects, counter positioning, switching costs, branding, cornered resource and process power. And I will not, I'm, this is not going to be a seven hour, we'll be on this podcast for another three hours if I take you through the whole thing.

But the, I think the other point, key point is, There are different powers that are available to companies at different stages in their sort of evolution. And so for us, it's like a venture investor. I think it's the one that, that most apply to startups are, and I think there's one really important one, which is counter positioning, which is the idea that.

You can, as a newcomer adopt a super, a business model that is superior to the incumbent, but they won't or can't copy it because of some sort of anticipated damage to their existing business. So I think we talked a little bit about AI a little bit in this framework, right? Like startups can and probably embrace it more aggressively than incumbents.

Because incumbents have got a lot more to lose. They're the ones who are going to get sued in, in big lawsuits. And if you eng, if you embrace all these tools really aggressively, you are gonna be, probably be making games at a, 1% of the cup, one five, 10% of the cost of a big company.

But then as these, as you as the com, as companies evolve, they tend to build other kinds of moats that make it really hard for other people to com compete with them. So in games, I would say network effects are a very, are quite common quite a common one, network effects and also scale economies and network effects being, if you have a game that Clash Royale, which I used to play a lot of they have a huge network effect in that, and the idea of a network effect is that the whole platform becomes more valuable with each edition, with it, with each incremental user that is added to it.

And in the case of a game that can be because, there's it helps with player liquidity. It also means other kinds of things around the ecosystem become more interesting, like you can build an eSports ecosystem around it, for example. So things like that. I think another one that's that's built into games a lot is switching costs.

The longer you spend in a particular game, Yeah, you and you're building a whole collection of stuff, you're probably reluctant, you know, all these skins and so on, you're sort of reluctant to move on from them. And then and then like another couple that are very relevant to game companies that are more later stage ones that.

Going back to the other point in our conversation, these are things that evolve over a long period of time are brand and process power. So brand, you really, there's no shortcut to building a brand. Like you can't build a brand quickly. Like brands are only built by repeatedly fulfilling a promise to a group of people over, over a long period of time.

And and then process power, which is, there are some games that are just incredibly. That certain studios are just much better at making because they have done so much to build infrastructure and resources to make those games.

Aaron: Yeah, we could spend a lot of time digging into all of those, but I'll fold this into a much simpler question, which is given all of those advantages, given all the technology trends we've talked about, given the state of venture and the games industry Based on all of that what do you see as underhyped, or undervalued, in the state of gaming today?

David: I will tell you, I'm gonna answer a slightly different question. Okay. Which is less, but thinking again about this idea of what's going on right now. That is a disruptive environment, shift that therefore I would want to, as a founder investigate. And the one that springs to mind for me literally like today, because I think it was announced like maybe just yesterday, I think this move that Meta has made to open up.

Their VR operating system and to pivot into becoming the sort of Android of the, I realized that the OS is actually, it's a fork of Android itself, but this idea that it's going to be moving away from this Apple like vertically integrated closed ecosystem, and it's going to be different kinds of devices with focused on different sorts of things.

That's the, that feels to me at a gut level, oh, things are being shaken up a little bit here. And there might be really interesting, that creates, that's going to just, you want, in venture and as an entrepreneur, you want, someone to come along and shake the, the snow globe, weird analogy, but you want things to be shaken up a little bit. And like that to me makes me think, whereas we have not yet made a VR investment and I speak as someone who has. A very early enthusiast. We were, I think my, gaming insights. We were one of the, we maybe hosted the first public demo of the first like developer version of the, the the DK one order it was called.

And and I think VR has consistently failed to fulfill the kind of the expectations that certainly we as venture investors need to, in order to underwrite. Making a company hitting that kind of growth trajectory that we want. I might be tempted to re evaluate that in the, in, in the light of what's happening, what may come in the wake of this.

Whereas I think actually I was pretty, I was keeping an eye on Vision Pro, but I think Vision Pro in its current form looks, Pretty dead on arrival, actually in terms of something that's a developer ecosystem. That's going to be all interesting in any way. That's top of mind for me this week.

Aaron: Yeah, that's not where I thought you were going to take that. So it's really interesting. I'm pretty bullish on. Both uh, meta from here and open sourcing their platform makes a ton of sense. And I think that even if you say that the Vision Pro is dead on arrival, there's a lot of levers Apple can pull to Oh, seeded telling a system, but yeah, it's exciting.

This is like the next clearest wave of consumer tech that, as you say, it shakes the snow globe. And where there's chaos, there can be opportunity. Yeah, so really interesting as little finger would say chaos is a ladder. Indeed. Well Said. Cool. Another question I have, given all the things we've talked about to the trends, the technology state of the market how does that impact?

Not just the kinds of companies that you're looking for, but like the way that you approach, constructing a portfolio as a venture firm right now how are you thinking about that bigger picture?

David: It's figuring out there's two, there's really two, two kinds of investment that we make. So we invest a pre seed and when I say pre seed, I really mean it's the, it's inception stage, right?

The company maybe has raised zero outside money or maybe a tiny amount from friends and family. And. What's quite interesting at Pre Seed is there's actually a huge range of valuations and expectations, amounts of money that people raise. And what we have concluded is what makes sense for us, coming back to like, what is our own unique, what are our own unique competitive advantages?

Both Joachim and I spent, 20 odd years as founders. And so we took the decision that our Pre Seed investing is going to be done Exclusively through a program we call co pilot, which basically involves us rolling up our sleeves, sitting down with an entrepreneur, helping them really work through their plan for the business and how it's going to be funded, their pitch, how they're going to tell the story of their company and make it in a way that is compelling to people like us, basically.

And then Their process, their fundraising process. So we'll actually actively get involved and reach out to VCs that we think are a good fit for the kind of thing that this company is doing. And we'll give our own pitch as to why we think that the other company is worth meeting with.

And in exchange for doing that, it's all sort of guest services for equity. But the way we structure it is we get a really compelling, Entry price, like a really much, much lower than some of the pre seed value. And we see a lot of stuff, as I've mentioned, we see a lot of stuff where there's really nothing more than a pitch deck and they're already trying to raise it, 10 million, pre money plus, but nothing's been de risked.

And so for us we don't really want to do deals. Like that, we want to instead at the very early stage use our entrepreneurial muscles to, to help influence that early trajectory of the company and earn the, that really good equity position. The other thing that it allows us to do from a sort of an investing perspective is most of the time when you, if you're talking to a company during a fundraise, that's a very constrained process.

Period of time during which to get to know some founders, right? Maybe you have a couple of meetings, two, three meetings. And then you do, you do your reference checks and you make a decision and if the round gets competitive, things can move very quickly. And, one advantage here is we can really get to know people outside of that typical fundraising cycle.

And that's something that we can use then to inform our future. We can reinvest if we feel like things are going really well. We have, you can't trade on insider information, in the public markets, but you absolutely can and you want to in the private markets.

And so it's a sort of a way for us to develop like stronger conviction by just having a working relationship with founders. And so we thought, okay, we want to do that as our precede investing. And then Yeah. Seed we invest on market terms. We're happy to pay up, quite meaningfully if there is strong evidence of product market fit and real traction that we can evaluate.

And so, uh, and we, and we don't want to do anything in between. And we found that to be quite clarifying. Because just the nature of venture is, we probably see. We probably see 1200 companies a year at least and you want, it's important to have some sort of heuristic that allows you to focus your brainpower on just the things that are like relevant for you.

And this is a good way for us to do that.

Aaron: That's exciting. And a really unique approach. And I'm excited to learn how that goes over the next few years and what you learn by getting into the trenches in a deeper, earlier way than other investors. I also want to give you a chance just to quickly, pitch this to, to any founders here who are listening, like what kinds of companies are, Like the best fit to, either get investment from you guys or to even consider working with you and the program you mentioned super early stage.

David: Yeah so look, we're really excited to meet founders like some of our investments we made. We started talking to the founder even before there was a company. And so that's, that's totally fine with us. We invest, as I say, in the future of media and communications. We love gaming founders that, games is so competitive and like so much about gaming is, Learning how to do incredibly good go to market and how to build highly engaging products.

I think there is huge opportunity for founders to take those skills and apply them in all sorts of other domains. There've been a lot of success stories from founders from games, taking their, those skills and building great companies elsewhere. We'd love to do more of those. I would say on the gaming, look, we do invest in games.

I think we're particularly excited about the more sort of solo developer uh, Um, doing something a bit weird. Again, we really love people who have a unique audience insight. We're still very much open for business on the gaming side, even though we do a lot of. Other things as well.

And I think beyond that we're pretty open. We try and get a response to everyone that pitches us. Just because I think as a founder, it was frustrated me to be, feel like I was firing emails into a black hole. So it might just be a quick no, but a quick no is a lot better than nothing.

So we'll don't ever hesitate to reach out. Yeah, as I say, we're really excited in both in the super early stage, working with founders in a very. Personal way and then if you're at seed and things are really going well then we'd love to talk to you as well Of course like us and every other vc on the planet but particularly if you're if your business could be accelerated by in some way by Really strong access into the sort of the gaming or the media ecosystem or broadly then we can be very helpful there, too

Aaron: Yeah, no, no downside in reaching out if people want to do that Where is the best place to connect with you or reach out?

David: You can email me. I'm [email protected]. Just the letter f number four fund. Similarly our website, F4 fund has a pitch form, which we, we do look at everything there. So either of those two ways probably the best.

Aaron: David, one last question. I've talked about your writing a bunch on this episode.

For those that want to get your essays and read them as soon as they come out, or should they, they go and sub subscribe to that?

David: You can just go to davidk.co and it'll take you to my sub stack

Aaron: Cool. Yeah, I strongly recommend it I'll also include the link to that in the show notes so you can see it very simply and easily there but with that David, I think that's the perfect place to wrap up.

Thank you as always For joining me on the podcast here, it's always fun talking to you and hearing about what's on your mind. And best wishes to you and F4 going forward.

David: Thanks, Aaron. It's been a pleasure.

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