November 17, 2007
This is the first in a 4 part series on VC investing in digital content, prompted by the discussion at a NewTeeVee Live panel discussion on the topic with myself, Tim Haley of Redpoint, George Zachary of CRV and Dennis Miller of Spark.
George was right when he said at the panel that most content opportunities are plauged by a “hits” business model. Movies, TV shows, videogames all are great examples of hits based plays: you invest tens of millions of dollars up front, pray for a blockbuster hit that returns your money many times over, but truth be told really have very little ability to predict success. As one of my partners says, being able to create a hit entertainment property is like creating lightning in a bottle – it actually does happen sometimes, but you never know when.
Most agree this is a bad fit for the VC model. Although our business has lots of risk and (though we hate to own up to it) lots of failed investments, over the years successful VCs have followed a formula which balances risk/reward along with amount of capital exposed. Time and again this formula has proven the one most likely consistently to generate good returns.
Here is what I mean by balancing both risk/reward and capital exposed:
Sometimes we see a very early stage project which we think has tremendous potential to be a big hit, but is so early or so risky that we know the odds of achieving the hit are not high. In those instances, if we love the entrepreneurs and think they have a real advantage, we sometimes will invest a small amount of capital to learn more. The calculated gamble is pretty straightforward: we know full well that we might lose every penny invested, but if the amount exposed is small enough, it is well worth that risk in order to see if the entrepreneur can make enough progress, and remove enough risk, that we are then willing to invest substantially more capital trying to go to market.
This is a classic profile for a “seed” investment. The key is that we limit how much capital is exposed in opportunities where the risk is exceptionally high. Over the course of a fund, we like to make a number such bets (and historically have had great returns with seed deals), balanced out by a larger number of less risky bets where neither the upside potential nor the risk is as extreme.
The problem with traditional “content deals” is that they invert the relationship between risk and capital requirements that makes the VC model work. While content deals are very risky and unpredictable, they require lots of capital up front. It feels like buying a $30MM lottery ticket. Only fun if you win.
So, while it is true that some folks with names like Malone and Diller have made a killing investing in content, it is a tough model. Rather than believing they have the midas touch of a Diller or Malone, VCs prefer the more proven model of only exposing a modest amount of capital when essentially taking a flyer. Which makes a heckuva lot of sense to me.