Funds are still finding kids digital startups – so what gives?

Despite the cutthroat nature of the kids digital startup world, securing financing is far from dead in the water. In fact, investment firms are doling out tens of millions of dollars at a time to certain kids interactive startups. So where exactly is the money going?
February 26, 2016

As a two-time Emmy winner, former TV network exec and AOL alum, Malcolm Bird knows a good idea when he sees it, which is what led the entrepreneur to launch the tween-targeted VOD and social media platform Viddiverse in May 2014. The ad-supported destination brought in a range of content from the likes of Zodiak Kids, Nelvana and Shaftesbury, as well as a sponsorship deal with toy giant Mattel. His ideas were in motion, but the dollars—not so much. With the New York-based startup unable to secure the crucial second round of investment it needed to take Viddiverse fully to market, Bird pulled the plug on all operations after 18 months.

“Our audience was small,” says Bird. “Advertisers are into new platforms, and audiences want new platforms, but the venture capitalists are actually very risk-averse,” he contends. “It’s a chicken-and-egg conundrum, though, because you need backing to build an audience. Viddiverse was a good calculated risk, and if it had worked, we would be sitting on a billion-dollar company.”

Bird’s experience with monetization is not an isolated one. In November, just days after Viddiverse closed its doors, six-year-old Boston-based digital media company CloudKid shuttered, citing changes within the interactive content landscape. The company, which had four Emmy Awards, a TV development deal and US$1.6 million in 2015 revenues in its corner, saw inherent challenges in monetizing kids interactive content, as well as shrinking budgets. In response, it moved to join social robotics startup Jibo.

Yet there’s a cohort of companies currently experiencing quite opposite outcomes. Investment firms are doling out tens of millions of dollars at a time to certain kids interactive startups. So where exactly is the money flowing? And what’s swaying its course? According to TechSavvy Global analyst Scott Steinberg, today’s financial backers are finding comfort—and solid returns—in companies that have steady, recurring revenues, rather than those that offer big one-off payouts.

“Investors are looking for a sustainable business model, not necessarily mass volume or registrants, but rather a platform that has people sign up and pay for a service. Subscription-based models are the new free-to-play,” says Steinberg, whose software and entertainment consultancy is based in St. Louis, Missouri.

Both Steinberg and Bird believe that investors are still recovering from burns left by an unpredictable, bubble-esque free-to-play mobile market, and VCs have become highly selective in financing kids entertainment platforms.

“Free apps were new and novel five years ago, but when you look at the actual nuts and bolts, there are only so many apps that have succeeded. Children have a small number of games that they use religiously,” Steinberg says. In fact, a September 2015 Adobe study found that 25% of apps are opened just once, and across the board, an app generally reaches half of its lifetime use in the first six months on the market. So mobile fatigue is posing an ongoing barrier for both developers and potential investors.

Even if the dollar signs are pointing at subscription-based platforms, the increasing reality of an over-saturated market means that there is less money to go around. Steinberg says a subscription-based startup requires a small customer base in place in order to attract investment, but audience numbers do not necessarily have to be huge.

“Social media marketing VCs need a proven concept, not just a proof of concept. Online video is through the roof in terms of consumption,” Steinberg says. “There’s so much consolidation, where brands and well-known properties are winning. There is room for breakout hits and sensations, but in those cases it’s best to have big, known brands behind you.”

Having a big brand and well-known third-party content in your corner is advantageous, but it can also be a deterrent. Nick Walters, CEO of subscription-based TV and learning app Hopster, believes there’s still plenty of money going into kids businesses. “You have prodcos and new IPs. What makes it tougher for us is that there is a dependence on third-party content,” he notes. “Conventional VCs are looking at traditional software, etc. But with kids, there is a creative risk and content involved, and oftentimes there is less comfort with that model. Plus, the bar is higher for digital kids businesses than others.”

Hopster, which for US$5.80 per month offers a slew of TV content and interactive games, has secured two investment rounds since launching in December 2013. Following an initial seed round, the company’s second round of funding took place in 2014, led by London investment house Sandbox & Co. It allowed the SVOD to expand into more than 100 territories in 2015 while simultaneously becoming the top-grossing kids app in the UK.

“The big part of our growth strategy is to expand as soon as possible. From the funding side, if you do it well, you can get into a continuous circle to get to the next level, which makes you a better bet,” says Walters. “Subscription offers an easier business to model and a clear revenue stream.”

By the time Hopster had secured that round of institutional funding from Sandbox, it had already been named one of the best apps of the year by Apple, and had accumulated a few hundred thousand subscribers. “We also got our timing right. We were bringing a product to market when there was a clear window for kids SVOD services,” says Walters.

And seeing this sort of scalable business potential is what led Bhav Singh and his team at Sandbox & Co. to invest in Hopster in the first place.

“The kids space is a bit of a jungle…But the reason it is also so attractive is because kids are early adopters”

- Bhav Singh, Sandbox & Co.

“My view is more strategic, rather than purely financial. I ask, ‘Can we build something of scale over the next five to 10 years?’ as opposed to just wanting a good investment,” says Singh. “The kids space is a bit of a jungle. There are ad restrictions and children aren’t the natural buyers. But the reason it is also so attractive is because kids are early adopters. When I consider this point, I think of IP-driven businesses, or a video-driven business, or what fits into engaged learning.”

Sandbox currently has nine products and/or assets in its portfolio, including Poptropica, Funbrain and SuperAwesome. “Are we willing to invest in a property without an audience? Yes. We just invested in Tada Kids, an original IP with learning elements that is being built from scratch,” says Singh. “There are tons of people making new platforms receiving funds, and these are the companies that are looking at what kids really want.” Without divulging how much money is going into such companies, Singh has seen the level of investment in the kids arena hover between a million to tens of millions.

Hopster’s Nick Walters also believes the future of kids tech funding rests in mobile platforms rather than web-based ones. A number of web-first properties aimed at kids have experienced financial roadblocks, as exemplified recently by the financial plight of children’s virtual world Moshi Monsters and its UK-based parent company Mind Candy. It saw a 57% slump in revenues from US$44.5 million to US$19.3 million in 2014, as well as US$20.5 million in year-on-year losses.

Singh says companies that have had to face the transition from web to mobile while simultaneously courting a young, fickle audience are seeing more red these days, and products that are sustaining consumers’ attentions—and meeting their technological needs—are catching the eye of his firm.

Gai Havkin, whose Israel-based startup KIDOZ has secured three rounds of funding—most recently US$3.5 million from Millhouse Capital, which is owned by Roman Abramovich and CIG Capital—is living proof of this concept.

Havkin’s content-discovery platform started as a safe browser for kids in 2009, at a time when PCs heavily controlled the market. Two years ago, Havkin ported his platform to mobile, which ushered in a breakthrough in terms of production.

“Moving to mobile was a good idea. Over the last eight months, we’ve made licensing deals with our own KIDOZ Mode safety tech, so it’s pre-installed on millions of tablet devices,” says Havkin. When the software doesn’t come pre-loaded, KIDOZ can be downloaded as an app—which has been done in Google Play more than two million times to date—that then takes over a mobile device and places it in a kid-safe mode. It’s essentially a walled garden containing 200,000 pieces of pre-approved kid-friendly content and games (both aggregated and licensed).

Meanwhile, parents can pay US$3 per month to access premium features. Aside from subscription revenues, the company makes money through its licensing deals with 40-plus manufacturers, as well as through recommended content, wherein brands can pay to promote their property to the KIDOZ audience.

“Investors today put money into companies that have technology that can produce other platforms,” says Havkin, adding that startups geographically located near the funding scenes of New York and Silicon Valley have traditionally had better chances at finding and getting capital. But as an Israeli company, he’s seen that changes are afoot, with big money from Chinese investors also being spent on kids digital and educational initiatives.

“Nowadays, it doesn’t really matter where you are, as long as your product is making money,” Havkin says. Even still, KIDOZ’s funding has led the company to open offices in both New York and China. “There are a lot of platforms out there that are great and want to go abroad, but people don’t always know how to do it,” he says. “China is definitely on the map for 2016.”

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