The Root Of Daily Fantasy Sports’ Problems? Venture Capitalists

Posted on October 14, 2015

During last month’s On Deck Sports and Technology Conference, FanDuel Co-Founder Rob Jones joined a panel entitled “How They Did It: Scaling a Sports Tech Startup.” At the outset, Forbes writer Brian Solomon asked Jones if he could share FanDuel’s founding story with the audience.

The story behind FanDuel and DFS

The story goes like this: Jones, Nigel Eccles, and a few others from Edinburgh, Scotland, conceived of a startup called Hubdub. Hubdub “was a web-based prediction market in which players used virtual money to trade predictions on future events.” (If you’re curious, you can still visit Hubdub’s website and see where FanDuel got its start.) The founders raised a seed investment round for Hubdub and began building the product and the company.

Over time, the founders realized that there wasn’t much of a market around predictions in politics or entertainment, but that they were finding traction with sports-based predictions. In what ought to be known as one of the most historic pivots among technology startups, Hubdub pivoted fully into fantasy sports and rebranded itself as FanDuel. Thinking they might be on to something, they pitched investors again.

And they pitched, and they pitched, and they pitched and pitched and pitched.

To hear Jones tell the story, venture capitalists in the United States and in Europe repeatedly passed on funding FanDuel. Eventually, the investor who originally funded Hubdub agreed to cut another check to keep them going and the team from Edinburgh had a little bit of fuel. They used that gas to build what would eventually become one of the biggest consumer technology success stories over the last five years.

Venture capital starts flowing in

Still, FanDuel grew modestly. The company raised a $4 million Series B before the 2011 NFL season when prize payouts stood around $10 million and an $11 million Series C in January 2013 when payouts stood around $50 million

But once FanDuel and its new competitor DraftKings began to seem like better bets, bigger checks started pouring in. First, $24 million for DraftKings in November 2013. Then $41 million more in August 2014. FanDuel responded by raising $70 million in September 2014. Then in July of this year both companies raised the big round: $275 million going to FanDuel and $300 million to DraftKings. The investors who had previously dismissed these companies now stood up and took notice.

Here, it’s important to understand how venture capitalists invest their money. Venture capitalists want to hit home runs. Because startups are incredibly risky and have a high likelihood of failure, VC’s seek to invest in companies that have the potential to become juggernauts in order to counteract the companies that inevitably turn to dust.

And they want this to happen quickly. VC’s are not buy-and-hold investors like Warren Buffett; they subscribe to a mantra that says “if you’re not growing, you’re dying.” So once VC’s realized that DFS companies could be multi-billion dollar entities, they wrote big checks to help these companies grow.

Growth means more customers. Growth means higher valuations in subsequent investment rounds, which increases the value of the VC’s shares. Growth is like oxygen to a startup. 

Capital spurs growth, but…

So the money went to growth. With this mandate, DraftKings and FanDuel spent money on media buying, ad creation, partnerships, infomercials, affiliate deals, content marketing — anything that could grow the user base.

The money went to growth because that’s what investors care about. Investors don’t care about regulation, sustainability, profitability, or security for losing players. The investors in DraftKings and FanDuel want the next investment round to be priced higher than the previous investment round so that they can mark up the value of their shares, and that’s not achieved by spending heavily on information security, internal controls, or player safety.

Daily fantasy sports is facing its first controversy. It is very real and entirely self-inflicted. The need to grow quickly forced each company to spend millions on advertising, which grabbed the attention of the mainstream media. The media saw DFS as gambling and couldn’t wait to report this story.

This controversy could have been avoided if each company had pumped the brakes ever so slightly.

But when there are billions of dollars at stake, taking it slow is never the gameplan.

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Dan Chaparian

Dan Chaparian is a contributor to Legal Sports Report. Dan is a media and technology professional who lives in New York City.

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