The cash crunch scenario

What happens when a games company foresees the point where the cash runs out, then goes to investors for a solution?

In the second of our blog series on reasons that games studios raise money, we’ll look at how investors react to a studio either deliberately or inadvertently in distress.

If you’ve got a sinking feeling in the pit of your stomach reading this, then you’ve obviously been near this difficult point in a games studio’s existence. I know we have!

But it’s not all gloom and doom.

Investors aren’t necessarily put off by a cash crunch. Their response depends on when it is and how you’re handling it.

2 flavours of cash crunch

There are 2 flavours of cash crunch as far as investors are concerned: planned and unplanned.

A planned cash crunch can be desirable for the right company. An unplanned one is only navigable with the right level of warning and approach.

Flavour 1: The planned cash crunch 

This is commonplace for start-ups in the wider tech world. These companies usually aren’t profitable for years and their business model revolves around continually raising finance until they’re viable. 

This exercise in brinkmanship is all about creating a belief in investors that you’ve spotted a gap in the market for a new product and will be able to establish product-market fit. Their cash burn rate and length of runway drives a nearly perpetual sprint to raise funds.

This kind of company does pop up from time to time in games - sometimes going big (like Improbable). These unicorns typically do so with groundbreaking technology, breathtaking ambition and breathless Silicon Valley backing (ditto), polished to a high gloss by stellar PR.

Most games tech companies grow carefully and organically, winning customers without cash crunches, then raising external finance once they’ve shown that studios will buy their products. If you’re one of the rare games tech companies in this position, you’ll almost certainly have raised funding before.

If your cash crunch and runways are part of your plan, investors will be receptive.

Investors love a well-thought through plan.

Flavour 2: The unplanned cash crunch

An unplanned cash crunch is also commonplace, sadly. In fact, many of us have been there (or at least in the vicinity) at some point. 

If your cash crunch is next week or even next month, that’s almost certainly too late to go through the typically lengthy process of raising a round. Unless your network has deep pockets and nerves of steel, investment won’t solve a cash crunch faced within under 10 weeks.

If the crunch is coming within the next 3 months or more, at least you’ve seen it coming to some extent…

Let’s face it, over a barrel is a tough position to negotiate and alarm bells will ring loudly for investors.

An investment round may not solve all the problems that caused the cash crunch in the first place. You’ll need to take a long, hard look at the company before entering the minefield that is fundraising in a crisis. 

A review of your cost base and revenue streams as well as your debt and equity position will be essential. An experienced and fresh pair of eyes on your situation could be very helpful here to explore other funding options alongside equity investment. 

Debt, liquidity finance or even convertible debt might work if you need working capital to plug a short-term gap until an otherwise viable company can generate revenue. If you’re in one of the countries offering tax reliefs, some lenders will provide finance if they see an interim certificate or a track record of winning a relief.

You may have to tackle the odd sacred cow to survive.

Serious measures such as shelving that original IP game, doing some work for hire, cutting staff might be considered.

Investors expect to see cold dash of resilience, realism and perhaps a little ruthless decision making when the chips are down.

What this means to the investor: Unless one of the rarer games companies that has a planned cash crunch, the chances are that the investor will be worried about the company being in distress.

OK you might’ve had a run of really bad luck or the runway from a previous investment round is running out. In this case, your earlier investors should be working with you to land a new round purely out of self-interest.

But an unplanned cash crunch can be a massive warning sign to an investor that something fundamental is wrong with the business. 

Some investors might see an opportunity to buy more of a good company at a low or even distressed valuation, but don’t count on it. And don’t forget, existing shareholders and options holders (including staff) may not like being diluted that much.

Some investors will appreciate your team’s honesty and ability to problem solve, but we’d expect more investors to say ‘thanks but no thanks’ when companies are raising during a serious cash crisis. Whatever happens, expect the scrutiny of your business model, cost base and revenue streams to be intense. 

What this means to the studio: You’ll need to be honest with any investor about your company’s position and your options for moving forward. That honesty - not sugar-coating the difficulties, facing the challenge head on, devising viable options that include some equity funding - will earn you more respect from potential investors than blind optimism or, worse, obfuscation. Come clean, bring the investor inside the tent and seek their advice. If they are the kind of investor you need - an investor that will roll their sleeves up when the chips are down - they will quickly prove their worth.

If you do succeed in raising investment, you will have to concede some key ground, certainly in terms of equity but ultimately of control. Your valuation won’t be optimal and you + your existing shareholders will be diluted. You might even face a down round (the new valuation is below the last valuation), or lose more voting rights.

Key takeaway: Look at the fundamentals, proceed with caution and don’t expect a favourable deal.

Sound easy?

No?

It’s not easy but it’s doable with the right advice.

We’re here to help.

You can access some of our products like our Pre-investment checklist (10 reasons to raise money for the first time and when to act on them), 5 ways to plug skills gaps in your top team’s experience, our forthcoming Games Investor Profiles, our Games Investment Deck template (with explanations and advice for creating a strong pitch deck), the Art of the Pitch (10 pitch recommendations to read BEFORE you do your first investor pitch)

You can also book an Investment Deck Review, conduct a Practice Pitch Session with us before you face the investors as well as a range of one to one advice from a team that has reviewed hundreds of games investment pitches.