Structuring for success — Part 2 of 3
In our first post of three on structuring for success, we looked at some of the issues that founders need to consider when establishing their operating entities. In this post, we turn to the subject of raising capital and focus on some of the more operational issues around running paid user acquisition campaigns, covering topics that founders need to be mindful of when preparing to scale.
Access to equity capital
Accessing the right capital at the right time is crucial for any business looking to scale. Different types of investors have different appetites depending on their fund’s investment criteria — stage, sector focus etc. But there will also be a geographic jurisdiction angle — where can they invest, and where they can’t or won’t invest. Either way, being able to offer investors a clean investable proposition is always a very important consideration when raising capital.
For angel investment at seed stage, the climate for domestic investment is normally strongest, particularly if there is a network of founders who have successful exits under their belt. From a fund standpoint, we’ve seen lots of smaller funds launch in countries like Turkey to focus on investment in domestic talent, which is a really positive step forward compared to ten years ago when virtually all of the focus was towards established US/EU/UK venture capital investors.
Some founders who have successfully exited their companies and want to proactively reinvest back into their own ecosystem become LPs in, or even set up seed funds which have then attracted additional domestic capital as well — another positive for domestic ecosystems.
In recent years, larger US/EU/UK VC funds have become much more open to investing in different jurisdictions outside of where they’re located in order to find the best companies to invest in. Factors such as increased remote working since Covid, and an openness to look outside high-cost living areas like Silicon Valley for the best talent have all played into this, with investors increasingly widening their geographical scope.
When looking for equity investors for your company, be sure to check out other portfolio companies and see if the fund has a track record of investing outside of its home territory, and particularly any history of investing in any territory you’re considering incorporating in. This will save you time and wasted effort down the line.
Keep in mind that the VC has their eyes on their potential exit and will want to make sure that structural and IP issues are all addressed before considering seeking a liquidity event. That said, many funds proactively work with the founding teams to optimize structures over time, so it’s not that everything needs to be perfect from day one.
From an investment standpoint it’s all about being comfortable operating in different countries and dealing with elements of risk, whether actual or perceived. For example, for European VCs, Cyprus is a popular and well understood jurisdiction, given its EU status and evolved legal and financial infrastructure. However, for them to invest directly into a studio domiciled in say Vietnam or Pakistan may be considered to have too much perceived risk as it’s deemed off-piste versus their normal scope of investments, plus they will likely have a lack of knowledge about local legislation and commercial infrastructure. This is a big reason why getting the overall structure of the entity (or group of entities) right is so important, such companies regardless of their home territory should be able to access the capital they need to grow.
An increasingly important part of the capital mix comes in the form of debt products that are used to leverage equity investment and in particular help companies scale through paid UA.
Debt products are increasingly being used as a capital-efficient financing tool to help companies grow, especially via paid UA, without relying on external equity capital. Thus it’s great for founders as they can grow without dilution, and their equity investors also like that their investee company is being efficient with their use of funds raised, using equity for at risk activities (such as creating new IP), whilst using debt to scale UA which, provided the numbers are well understood, has a lower risk profile.
Specialist lenders like Pollen VC look closely at the domicile of entities with a particular focus on being able to take the necessary security to back up the credit facility. Their ability to lend to a company will likely be dependent on the secured lending environment of that country. Picking a jurisdiction that has an evolved secured lending environment (such as public registers of charges/liens) is important, particularly if looking to access capital internationally.
Of course there will always be domestic banks that can be approached to provide debt to the company to help it grow, but typically their understanding of the nuances of how games and apps are monetized is very poor, so any debt products such as term loans offered are not really fit for purpose.
It should be noted that some countries such as Turkey impose additional taxes (in this case it’s known as RUSF) on loans made by international lenders making it prohibitively expensive for them to provide debt products to domestic studios. Loans may also be subject to withholding tax if made from outside the jurisdiction, so this needs to be analyzed too as part of the overall criteria of deciding on optimal jurisdiction.
Be careful to keep in mind that not all debt products are created equal and products like revolving credit facilities offer a much better fit to scale games and apps than revenue-based loans, invoice factoring or bank term loans. For more information on this please download our Definitive Guide to Selecting a UA Financing Partner.
One of the largest constraints we come across with regard to jurisdiction is a company’s ability to scale using paid UA efficiently. Given this is such an important part of the ecosystem, it’s something that continually trips studios up and thus justifies really thinking through upfront to avoid issues down the line.
Spending on UA with leading ad networks is an essential part of scaling a successful app or game. It’s really important to have well understood unit economics, track the behavior of marketing cohorts and have a really strong grasp of the underlying ROAS and LTV metrics. It’s not the intention of this post to focus on the underlying unit economics, but more on the operating model to ensure successful and sustainable UA spend.
Firstly, it’s really important to understand how ad networks operate in terms of frequency and scale of ad spend. Their algorithms favor predictable (ideally growing) spend over time such as in a controlled ramp up environment. Going from zero to $50,000 per day and then back to zero when the money runs out is going to ruin your UA strategy. So it’s essential to plan cash flow for a smooth and steady spending trajectory to get the best performance, and manage your cash flow accordingly.
Most studios start by paying on credit cards or allowing frequent direct debits from their bank account, depending on territory. This allows the networks to become comfortable with their ability to spend, and there will be different limits set to guard for fraud etc as they start to scale.
Over time it’s likely that the studio will be offered a credit line from the network. This will allow them to spend up to their credit limit and settle the bill, normally on Net30 payment terms, in other words at the end of the following month in which the UA spend takes place. Studios should always take advantage of credit lines offered by ad networks as it’s effectively a transfer of risk on LTV recovery from you to them.
However, ad networks have a notoriously manual approach to offering credit lines, and it is not only very dependent on spend history, but also on other factors such as company jurisdiction. It’s different network by network, but diligence on giving credit lines typically happens in a very old fashioned way where the company needs to show a trading and spend history, and normally has to submit bank statements and sometimes tax returns in order to pass a manual review process.
The process for applying for credit facilities is much easier in US/EU and other territories where the perceived risk is higher for the ad networks, who are effectively taking unsecured trade credit on growing studios. The more opaque the commercial operating environment, the harder it will be for the studio to obtain a credit facility, given the perceived risk to the ad networks who typically have a very US/EU centric viewpoint.
The major ad networks are much more reluctant to provide trade credit to studios in countries like Vietnam, Pakistan, Brazil to name just a few, despite significant commercial opportunities existing. They are perceived as being harder to enforce should recovery be necessary and a lack of local understanding sometimes just puts these countries in the “too difficult” box for the ad networks.
For studios seeking to manage their spend using credit cards, it’s important to understand if there are specific restrictions on international card spend. For example, Pakistan recently introduced a cap of $30,000 per annum on foreign card spend. This type of restriction can be very detrimental to studios looking to scale their UA spend operating from a domestic entity in a more challenging jurisdiction such as Pakistan.
In getting the entity structuring right, where the publishing entity is in the right jurisdiction, the studio has a direct relationship with Google, Meta etc. and it becomes easier to build up trade credit history and then ultimately apply for credit facilities as well as an account management relationship as you start to scale.
So again, this brings us back to the point of structuring and jurisdiction. It’s critical for the studio to think through the issue of jurisdiction before starting to scale their ad spend, otherwise they could run up against real challenges in the scale-up phase, no matter how great their metrics are.
Monetization — IAP and ads
IAP monetization is pretty straightforward. Both Apple and Google pay out IAP revenue according to their normal payment cycles. Whilst Apple lets you nominate your currency of choice among a range of currencies, Google normally will only pay into a bank account in the currency where the entity is domiciled. In addition to that, then insist that the IBAN of the receiving account is issued by a domestic institution, for example an IBAN starting DE for Germany or CY for Cyprus.
This causes many studios a headache as they are forced to operate across multiple currencies, which makes their modeling of UA/monetization financial return scenarios more complex. Many companies operate all UA and monetization in USD, so it can be problematic, especially with Google, when payouts are received in a domestic currency which must then be converted to USD.
With regard to ad monetization, many of the networks are only geared up to make USD payments. So either the studio needs to operate a USD account, or their bank may perform a forced conversion of USD funds hitting their bank account at whatever the bank’s prevailing rate happens to be (typically high FX cost to the studio).
Where it’s easy to hold a USD denominated bank account (think UK/EU, and obviously USA), this is no problem. But as soon as you get into operating USD bank accounts, let’s say in Turkey, Vietnam, Brazil or Pakistan, things can get a lot more complex and issues such as currency controls and restrictions on foreign payments start to become an issue.
Again, all of this can be solved through thoughtful structuring. If the publishing entity as well as the ad serving entity is domiciled in a more friendly jurisdiction, then ad monetization becomes a lot easier for the studio.
Having a well oiled UA and monetization machine is at the heart of a successful app or game operating at scale. It cannot be underestimated how important this is for the studio to be able to operate so they can maximize the UA/monetization opportunity. Of course, by doing this everyone around the table wins, not least the app stores and ad networks. More money is spent on UA, and more money is made on ad monetization, so whilst, most importantly, the studio is able to scale and make great profits, the major players benefit greatly also.
In our final post on this series, we’ll be suggesting a blueprint for success — some criteria and best practices of app and gaming studios who have created successful overseas structures that have enabled them to scale efficiently.
This article was originally posted on pollen.vc/blog.