Economic Frustration Common for CE, Game Startups Seeking Funding

“Everything got worse” since the economic crisis started, said Bill Gardner, a CE and videogame industry veteran who’s now a managing partner at consulting company Digital Entertainment Insights, whose clients include new companies out to raise funding. He mentioned instances in recent months in which venture capitalists had pledged money to startups, but when the companies “went for the ‘cash call’ they didn’t get the pledged money.” Some of the pledged money was gone due to the Bernie Madoff scandal, while some of it was pulled back just because of “fear” on the part of the VCs, while some of it was just a matter of investors wanting to perform “more diligence,” he said without naming specific companies or VCs. The worst time was in October and November, “when my clients just dried up,” he said.

A new company looking to be a “traditional developer of packaged games has very little shot” of receiving funding now, Gardner said. But if a new game company is “focused on some form of online direction where there is a new model for gaining subscribers or getting advertisers to flow into their locale -- say social networks or cloud computing or something like that -- then money will come,” he said. Without such a focus, he said, “it is not difficult to get in the door -- it is impossible.”

Vector Entertainment was “really fortunate” to partner with a VC early in 2008 as it attempted to create the casual massively multiplayer online racing game Vector City Racers, its CEO, Chris Bergstresser, told us. The early-stage VC, Meakem Becker, “took a big leap of faith considering they had never been in the game space before,” he said. Meakem Becker provided an initial $1 million in January 2008, then invested another $3 million in June 2008, $1 million more in March 2009 and another $1 million last month, he said. “We are well funded through” the planned September commercial launch of the game, which is now in open beta with more than 5,000 accounts created to date, he said.

Vector’s been luckier than many startup game firms, but it hasn’t been immune from the current situation either, Bergstresser said, noting his company had yet to convince investors besides Meakem to provide funding. “The one frustrating aspect about this marketplace,” especially when it comes to games, “is that many VCs out there want” to hear some sort of “market validation” of a game before they are willing to provide any funding, he said. For example, investors other than Meakem have been hesitant to provide funding until they see the game site’s traffic level become more significant, he said.

Bergstresser believes it would have been tougher to get the same level of funding it has to date if his company had started raising money after the economic crisis hit, he told us. “We would have had to have shown a substantially larger investment in prototyping” through angel investors and “wherever we could claw and scrape pennies,” he said. “I think what VCs are looking for now is a substantially lower risk profile on any given investment. I'm generalizing -- I'm sure there are some out there that are ready to jump in and make investments that are slightly higher risk -- but thus far we haven’t found them. Even investors who say on their Web sites ‘we invest in early stage,’ they're not investing in early stage anymore,” he said.

Also luckier than many other startups has been CE company Maverick Lifestyle, maker of Bluetooth headsets. Its CEO, Craig Janik, told us his company doesn’t currently need funding. But Janik told us he was on the board of another CE company trying to get a round of funding. “Investor activity has chilled quite a bit” and funding has been “basically shut off completely,” he said. There are companies out there now, he said without naming them, “that would have been pretty healthy,” but are instead “looking at dire circumstances because of the drying-up of investor interest.” Previously, when trying to find a buyer for a new company or a round of investment, “the general rule of thumb was eight times EBITDA,” but “that’s kind of thrown out the window” now and investors “are coming in with really low-ball offers,” he said. Another CE company he’s on the board of has been looking for a buyer, but “the offers came in dramatically low,” he said. Both companies he’s on the board of are now operating without needed funding, he said, adding they are surviving for now, but their situation “limits growth.”

There’s also “been a slight tightening” at the banks in terms of small companies receiving lines of credit, Janik said. But he said some banks, including Wells Fargo, which Maverick uses, “weren’t really exposed much to the sub-prime” mortgage crisis, so there isn’t a significant problem now getting lines of credit and business loans.

Also impacted by funding woes has been Radiient Technologies, creator of a wireless surround sound technology that was unveiled at CES in 2008. A co-branding deal with THX was disclosed at CES this year that would see the technology marketed as THX Roomcaster. But since January, the CE industry “has really gone into a tailspin in the audio space,” said Radiient CEO Jano Banks. Radiient had three OEM CE customers “who were planning to go to market at the end of this year and early next year” with products incorporating its wireless technology, he said. One customer was planning a wireless home theater in a box-type product incorporating Blu-ray, he said. But all three OEMS “at the end of Q1 have had to put their programs on pause” due to funding issues, he told us without naming the customers. One problem is that customers who in the past had R&D budgets to fund new products and often used their non-recurring engineering budgets do “not have any budgets for such things” anymore, he said. Product managers were told they can only work on products that required “no money out of pocket,” he said.

In the four years that Radiient has existed, it’s raised $4.2 million from investors, Banks said. But he said that “since late last year, the angel market has gone to zero roughly.” A few angel investors have participated in multiple funding rounds, but “that community is very hurting and largely affected by the drop in the market because these individual investor types, of course, had a lot of their investments in the stock market, so their portfolios have taken a big hit,” he said. While Radiient was able to raise more than $1 million on three different occasions, this year, he was only able to raise $30,000 as of early June, he said.

Whenever Radiient has had a funding issue, it’s found ways to generate revenue by being “resourceful,” Banks said. For example, it’s consulted for short periods of time, he said. But when Radiient’s executives do consulting work, R&D at the company “gets stalled,” he said, noting that’s what’s happened now. The consulting work it’s done recently is “allowing us to continue, but the result of that is that our products are on pause as well” for now, he said.

An additional concern is what could happen if the consulting jobs dry up, Banks said. The economy seems to be doing better now, but he said “dependencies on consulting contracts as other companies also go through difficulties makes it uncertain.” Because consulting jobs can dry up, “we have to be very quick on our feet and always have another set of jobs lined up because we don’t know how stable the job is that we're doing,” he said.

Radiient pursued venture capital funding “for the first time last year” and the timing was bad, conceded Banks. “We're right here in Silicon Valley and we have board members who are very well connected,” but that didn’t help, he said. “The ability to get venture capitalist funding for consumer electronics plays is virtually impossible” now, he said. The only things that are being funded now are “green and clean tech -- that’s the hot market, if you will, in the venture community,” he said. A company can also try to borrow money or development funds, but “the credit markets are incredibly difficult right now” also, he said.

Radiient continues to try to promote its technology with THX, but the audio industry “is hurting quite a bit” now in general, Banks said. Some of Radiient’s “key customers have experienced some extreme cutbacks,” he added.

Banks also recently met with a company that’s “doing innovative things with low-power amps for speakers,” which he said is “very good for wireless” and could create “a battery- powered speaker” with a battery “that lasts for a month,” he said. But “they have experienced the exact same thing we have” in terms of funding, he said. That company, which he didn’t name, “has engineering work to do to bring these technologies to market and there are no customers, nor investors who right now have the funds to fuel that R&D,” he said. “Finding even $25,000 from an angel investor these days for consumer audio is virtually impossible,” said Banks. As it stands, no products using Radiient’s technology have come to market yet, he said.

Echoing him was Paul Chen, CEO of new videogame company Vivo Products, which is planning to integrate hardware and software into a console title. “It is very challenging” now to raise funding, he said. Having videogame industry veteran Bernie Stolar, ex-Sony Computer Entertainment, as chairman is “very, very helpful” for the company, “but everything is affected because of the economy,” Chen said.

Vivo has been secretive on details of its planned initial product. It’s now “in the process of going around raising a round A” of funding and “we've gone to talk to venture capitalists, angel investors -- everybody under the sun basically,” said Chen. “I will tell you literally I have personally talked to about 30 to 40 different VCs and angel groups.” But it’s been tough getting backers among any of them, he said. Some say they “love the concept” but are hesitant to back Vivo because they already invested in companies that are experiencing challenges, he said. “They're just not in a position where they have the resource flexibility to look into investing in a lot of new companies. They've got to stay liquid in the event that one of these companies that they've currently invested in” has some trouble and they have to help them, he said. Some VCs are just focused on categories they feel are stronger than games given the weak economy, he said, noting some have shifted from games to “renewable energy and green initiatives.” A “third challenge that we've run into a lot of times” is that investors “simply don’t get our business -- they just don’t understand it” no matter how much it tries to educate them. It’s also taking a “longer and longer” amount of time for anything to happen, he said.

Vivo started looking for funding in December after raising “a seed round” in October, and it’s been “actively engaged in talking to investors -- VCs and angels -- over the course of the last six to seven months,” said Chen. He conceded it was “probably one of the worst times” to have to try to find funding, but said “you don’t dictate when a business starts and when you start doing things.” He declined to say how much was raised in the seed round, but told us the money came from private investors and not institutional ones. The company originally hoped the initial funding “would carry us through this 12-month time frame and it would get past the current economy,” but “very quickly we realized that we wouldn’t be able to do that, so we started looking at doing a second round in December,” he said. “We've got interested parties, but everything is just taking so much longer from the standpoint of just people getting back to us,” he said. The situation is “frustrating, but at the same time it’s understandable,” he said.

As a result of the difficulty in raising more funds, Vivo “had to cut back a lot, as a lot of companies have,” said Chen, telling us it laid off about 70 percent” of staff and “ended up moving to a smaller office.” It had about 15 employees, and now has only four full-time people and a part timer, he said. The company also had to start subcontracting more work, he said, noting “the original plans were to do a lot more in-house.” Its overall plans “will probably take longer to execute than we had originally planned,” he said. The company had planned to launch its first game late this year or early next year, but now “middle to late next year, 2010,” seems more likely, he said.

Various investors we tried polling didn’t respond to requests for comment. But a few VCs told the recent GamesBeat conference in San Francisco they're still seeking out new game strategies to back despite the economic downturn (CED March 25 p6). “We're looking for what we always look for,” including “great leaders,” companies that can deliver “predictable monetization” and those that can develop a “niche” they can “win in,” said Benchmark Capital Partner Mitch Lasky. “There clearly is money to be made” in the game market still, he said. Norwest Ventures investors, however, aren’t looking to invest in games, but rather game market “disruptions” -- strategies that challenge the status quo, said Timothy Chang, a principal at the company.

Even established CE firms haven’t been immune to the economic crisis and its accompanying credit crunch. At least some banks are “being a little bit tighter” with their lending, said Chris Byrne, president of NHT. Nearly all lending through banks is done on asset-based lending in the CE business and typically it involves a formula against accounts receivable and good inventory that’s still on a company’s product sheet and selling on a regular basis, he said. Banks generally finance somewhere between 25 and 50 percent of the value of that segment of inventory, and can also “finance as much as 75 percent of your receivables depending on the quality of the account,” he said. The latter area is “where things are getting really tight for us because of the shakiness of the economy,” he said.

NHT “sells to a lot of installers,” as well as smaller distributors, and “the banks are nervous about a lot of those people” now, Byrne said. If NHT sold its products to a major retailer like Best Buy, there might be less concern among lenders. As it is, Amazon is now NHT’s largest retail account, but the e-tailer is only a “minor” part of the speaker maker’s overall business, he said. NHT’s “bad debt has grown like everyone else’s has over the last six months,” he said. And it comes at a time when “banks are a little bit more nervous, and they're looking harder at the quality of a company’s assets,” he said. CEOs at other CE companies have told him they're facing the same issues now, he said. But Byrne said he had not heard of “any wholesale pulling of lines, reducing of lines, things like that.”

Echoing the startups, Byrne said he had heard there was no private money available for CE companies to get funding. “It ain’t out there. It’s just not there. They're not financing.” But he said, “unless you've got a technical patent,” CE companies that sell speakers have “always been a very difficult sell for private investment” funds. Yet it’s only become tougher, he said. “I think it would be almost impossible for a small, fairly new company with maybe less than three years history to get a bank line right now.” Even selling a company now “is a very difficult thing to do,” he said.

Audio supplier Parasound, however, hasn’t witnessed such a problem, its president, Richard Schram, told us. To the contrary, Schram said, Parasound’s bank “has been pressing us pretty hard to give us a credit line even though I told them I don’t intend to use it.” That “suggests to me that that bank at least really needs to get some credit on their books, and I guess they considered us a good enough risk,” he said without naming the bank. He wound up turning the bank down, he said. “Particularly in these times, it’s our objective to basically live within our means and until the economy is showing a predictable robustness that would give us further reason to consider” a line for growth, Parasound won’t take on such debt, he said.