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Rec Room Part II (with CEO Nick Fajt)

Season 8, Episode 4

Limited Partner Episode

March 23, 2021
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The Complete History and Strategy of Rec Room


Last Acquired left the plucky Rec Room crew in our 2018 "Part I" episode, they were a seed stage startup making a VR game that users loved but grew slowly and barely monetized. Fast forward to today, and they're now a multi-platform social "place" with millions of active users, 500%+ YoY growth and a robust creator economy that's rivaled only by their oft-compared metaverse cousin Roblox in dynamics and efficiency. And oh yeah, they're now a $1B+ company after a new $100m fundraise from existing investors Sequoia and Index, which they're announcing today. We figured it was high time to revisit Nick & crew for a Part II...

If you love Acquired and want more, join our LP Community for access to over 50 LP-only episodes, monthly Zoom calls, and live access for big events like emergency pods and book club discussions with authors. We can't wait to see you there. Join here.

The Rec Room Playbook:


1. It's ok not to have a grand plan from the beginning.

  • As Nick says, company founding stories tend to get romanticized in retrospect. (Guilty as charged here at Acquired!) As a founder it can feel like there's so much pressure on you to "have it all figured out" from day one. But the reality of most great company beginnings is nothing so grand: often it's just founders who have an inkling about something interesting and the combination of courage + right life circumstances to jump into the unknown and learn as they go. Things change quickly in new or evolving markets, and if you're too wedded to a master plan you're likely to miss more opportunities than you seize.

2. Don't let early (or even just recent) success blind you if potential headwinds are on the horizon.

  • Rec Room experienced "explosive" growth during the 2017 holiday season with the launch of Playstation VR. However this was a classic "wiggle of false hope" (in Paul Graham parlance), not real product-market fit. It would have been easy to ignore the very real warning signs (e.g., that VR adoption as a whole was slowing) and plow full steam ahead. Instead the team realized they probably needed to step back from the temporary momentum and diversify out of solely focusing on VR to find new avenues for growth.

3. Build your company into a robust organism.

  • Startups constantly face existential risks: what if the market shifts? What if we make wrong strategic decisions? How can you architect your business as a system so that "you" (either you personally or the company management as a whole) doesn't need to always be right in order to succeed? For Rec Room this has meant investing deeply into UGC and letting creators lead growth. Any room or piece of content might be no more likely to breakout than another — but in aggregate across now millions of creators, Rec Room is almost guaranteed a constant stream of "hits".

4. UGC is a flywheel that's difficult to start, but creates incredible business dynamics once spinning.

  • Like any flywheel, UGC requires a ton of effort to get moving in the beginning. (E.g., why should people bother to create? What tools do they need? How do you get the incentives right?) But once momentum takes over, it can become an incredible virtuous cycle where users' creativity inspires more users both to consume and create themselves, which compounds faster and faster over time.
  • Furthermore, once a UGC flywheel is spinning, the underlying platform's unit economics get pretty fast: costs to produce content go down (or to zero), cost to acquire users go down (or to zero), and retention, engagement and monetization all spike up. In previous eras Facebook, YouTube, Instagram and Twitch rode to this dynamic to incredible success. Today Roblox, Rec Room, TikTok and others are following the same playbook.

5. When operating a "metaverse", the best business dynamics result from having everything on a single platform (vs. siloing users based on devices/geos/etc)

  • Having all users able to interact on one platform not only maximizes liquidity across the creator-consumer marketplace, but affords the company more power across brand (e.g. Rec Room is the sole brand, not "Rec Room on xbox/steam/VR/etc") and central economic control.


Links:


Sponsors:

  • Thanks to Tiny for being our presenting sponsor for all of Acquired Season 8. Tiny is building the "Berkshire Hathaway of the internet" — if you own a wonderful internet business that you want to sell, or know someone who does, you should get in touch with them. Unlike traditional buyers, they commit to quick, simple diligence, a 30-day or less process, and will leave your business to do its thing for the long term. You can learn more about Tiny here.
  • Thank you as well to Vouch and to Capchase.


Carve Outs:

We finally did it. After five years and over 100 episodes, we decided to formalize the answer to Acquired’s most frequently asked question: “what are the best acquisitions of all time?” Here it is: The Acquired Top Ten. You can listen to the full episode (above, which includes honorable mentions), or read our quick blog post below.

Note: we ranked the list by our estimate of absolute dollar return to the acquirer. We could have used ROI multiple or annualized return, but we decided the ultimate yardstick of success should be the absolute dollar amount added to the parent company’s enterprise value. Afterall, you can’t eat IRR! For more on our methodology, please see the notes at the end of this post. And for all our trademark Acquired editorial and discussion tune in to the full episode above!

10. Marvel

Purchase Price: $4.2 billion, 2009

Estimated Current Contribution to Market Cap: $20.5 billion

Absolute Dollar Return: $16.3 billion

Back in 2009, Marvel Studios was recently formed, most of its movie rights were leased out, and the prevailing wisdom was that Marvel was just some old comic book IP company that only nerds cared about. Since then, Marvel Cinematic Universe films have grossed $22.5b in total box office receipts (including the single biggest movie of all-time), for an average of $2.2b annually. Disney earns about two dollars in parks and merchandise revenue for every one dollar earned from films (discussed on our Disney, Plus episode). Therefore we estimate Marvel generates about $6.75b in annual revenue for Disney, or nearly 10% of all the company’s revenue. Not bad for a set of nerdy comic book franchises…

Marvel
Season 1, Episode 26
LP Show
1/5/2016

9. Google Maps (Where2, Keyhole, ZipDash)

Total Purchase Price: $70 million (estimated), 2004

Estimated Current Contribution to Market Cap: $16.9 billion

Absolute Dollar Return: $16.8 billion

Morgan Stanley estimated that Google Maps generated $2.95b in revenue in 2019. Although that’s small compared to Google’s overall revenue of $160b+, it still accounts for over $16b in market cap by our calculations. Ironically the majority of Maps’ usage (and presumably revenue) comes from mobile, which grew out of by far the smallest of the 3 acquisitions, ZipDash. Tiny yet mighty!

Google Maps
Season 5, Episode 3
LP Show
8/28/2019

8. ESPN

Total Purchase Price: $188 million (by ABC), 1984

Estimated Current Contribution to Market Cap: $31.2 billion

Absolute Dollar Return: $31.0 billion

ABC’s 1984 acquisition of ESPN is heavyweight champion and still undisputed G.O.A.T. of media acquisitions.With an estimated $10.3B in 2018 revenue, ESPN’s value has compounded annually within ABC/Disney at >15% for an astounding THIRTY-FIVE YEARS. Single-handedly responsible for one of the greatest business model innovations in history with the advent of cable carriage fees, ESPN proves Albert Einstein’s famous statement that “Compound interest is the eighth wonder of the world.”

ESPN
Season 4, Episode 1
LP Show
1/28/2019

7. PayPal

Total Purchase Price: $1.5 billion, 2002

Value Realized at Spinoff: $47.1 billion

Absolute Dollar Return: $45.6 billion

Who would have thought facilitating payments for Beanie Baby trades could be so lucrative? The only acquisition on our list whose value we can precisely measure, eBay spun off PayPal into a stand-alone public company in July 2015. Its value at the time? A cool 31x what eBay paid in 2002.

PayPal
Season 1, Episode 11
LP Show
5/8/2016

6. Booking.com

Total Purchase Price: $135 million, 2005

Estimated Current Contribution to Market Cap: $49.9 billion

Absolute Dollar Return: $49.8 billion

Remember the Priceline Negotiator? Boy did he get himself a screaming deal on this one. This purchase might have ranked even higher if Booking Holdings’ stock (Priceline even renamed the whole company after this acquisition!) weren’t down ~20% due to COVID-19 fears when we did the analysis. We also took a conservative approach, using only the (massive) $10.8b in annual revenue from the company’s “Agency Revenues” segment as Booking.com’s contribution — there is likely more revenue in other segments that’s also attributable to Booking.com, though we can’t be sure how much.

Booking.com (with Jetsetter & Room 77 CEO Drew Patterson)
Season 1, Episode 41
LP Show
6/25/2017

5. NeXT

Total Purchase Price: $429 million, 1997

Estimated Current Contribution to Market Cap: $63.0 billion

Absolute Dollar Return: $62.6 billion

How do you put a value on Steve Jobs? Turns out we didn’t have to! NeXTSTEP, NeXT’s operating system, underpins all of Apple’s modern operating systems today: MacOS, iOS, WatchOS, and beyond. Literally every dollar of Apple’s $260b in annual revenue comes from NeXT roots, and from Steve wiping the product slate clean upon his return. With the acquisition being necessary but not sufficient to create Apple’s $1.4 trillion market cap today, we conservatively attributed 5% of Apple to this purchase.

NeXT
Season 1, Episode 23
LP Show
10/23/2016

4. Android

Total Purchase Price: $50 million, 2005

Estimated Current Contribution to Market Cap: $72 billion

Absolute Dollar Return: $72 billion

Speaking of operating system acquisitions, NeXT was great, but on a pure value basis Android beats it. We took Google Play Store revenues (where Google’s 30% cut is worth about $7.7b) and added the dollar amount we estimate Google saves in Traffic Acquisition Costs by owning default search on Android ($4.8b), to reach an estimated annual revenue contribution to Google of $12.5b from the diminutive robot OS. Android also takes the award for largest ROI multiple: >1400x. Yep, you can’t eat IRR, but that’s a figure VCs only dream of.

Android
Season 1, Episode 20
LP Show
9/16/2016

3. YouTube

Total Purchase Price: $1.65 billion, 2006

Estimated Current Contribution to Market Cap: $86.2 billion

Absolute Dollar Return: $84.5 billion

We admit it, we screwed up on our first episode covering YouTube: there’s no way this deal was a “C”.  With Google recently reporting YouTube revenues for the first time ($15b — almost 10% of Google’s revenue!), it’s clear this acquisition was a juggernaut. It’s past-time for an Acquired revisit.

That said, while YouTube as the world’s second-highest-traffic search engine (second-only to their parent company!) grosses $15b, much of that revenue (over 50%?) gets paid out to creators, and YouTube’s hosting and bandwidth costs are significant. But we’ll leave the debate over the division’s profitability to the podcast.

YouTube
Season 1, Episode 7
LP Show
2/3/2016

2. DoubleClick

Total Purchase Price: $3.1 billion, 2007

Estimated Current Contribution to Market Cap: $126.4 billion

Absolute Dollar Return: $123.3 billion

A dark horse rides into second place! The only acquisition on this list not-yet covered on Acquired (to be remedied very soon), this deal was far, far more important than most people realize. Effectively extending Google’s advertising reach from just its own properties to the entire internet, DoubleClick and its associated products generated over $20b in revenue within Google last year. Given what we now know about the nature of competition in internet advertising services, it’s unlikely governments and antitrust authorities would allow another deal like this again, much like #1 on our list...

1. Instagram

Purchase Price: $1 billion, 2012

Estimated Current Contribution to Market Cap: $153 billion

Absolute Dollar Return: $152 billion

Source: SportsNation

When it comes to G.O.A.T. status, if ESPN is M&A’s Lebron, Insta is its MJ. No offense to ESPN/Lebron, but we’ll probably never see another acquisition that’s so unquestionably dominant across every dimension of the M&A game as Facebook’s 2012 purchase of Instagram. Reported by Bloomberg to be doing $20B of revenue annually now within Facebook (up from ~$0 just eight years ago), Instagram takes the Acquired crown by a mile. And unlike YouTube, Facebook keeps nearly all of that $20b for itself! At risk of stretching the MJ analogy too far, given the circumstances at the time of the deal — Facebook’s “missing” of mobile and existential questions surrounding its ill-fated IPO — buying Instagram was Facebook’s equivalent of Jordan’s Game 6. Whether this deal was ultimately good or bad for the world at-large is another question, but there’s no doubt Instagram goes down in history as the greatest acquisition of all-time.

Instagram
Season 1, Episode 2
LP Show
10/31/2015

The Acquired Top Ten data, in full.

Methodology and Notes:

  • In order to count for our list, acquisitions must be at least a majority stake in the target company (otherwise it’s just an investment). Naspers’ investment in Tencent and Softbank/Yahoo’s investment in Alibaba are disqualified for this reason.
  • We considered all historical acquisitions — not just technology companies — but may have overlooked some in areas that we know less well. If you have any examples you think we missed ping us on Slack or email at: acquiredfm@gmail.com
  • We used revenue multiples to estimate the current value of the acquired company, multiplying its current estimated revenue by the market cap-to-revenue multiple of the parent company’s stock. We recognize this analysis is flawed (cashflow/profit multiples are better, at least for mature companies), but given the opacity of most companies’ business unit reporting, this was the only way to apply a consistent and straightforward approach to each deal.
  • All underlying assumptions are based on public financial disclosures unless stated otherwise. If we made an assumption not disclosed by the parent company, we linked to the source of the reported assumption.
  • This ranking represents a point in time in history, March 2, 2020. It is obviously subject to change going forward from both future and past acquisition performance, as well as fluctuating stock prices.
  • We have five honorable mentions that didn’t make our Top Ten list. Tune into the full episode to hear them!

Sponsor:

  • Thanks to Silicon Valley Bank for being our banner sponsor for Acquired Season 6. You can learn more about SVB here: https://www.svb.com/next
  • Thank you as well to Wilson Sonsini - You can learn more about WSGR at: https://www.wsgr.com/

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Transcript: (disclaimer: may contain unintentionally confusing, inaccurate and/or amusing transcription errors)

Ben: Welcome to season 8 episode 4 of Acquired. The podcast about great technology companies, and the stories, and playbooks behind them. I'm Ben Gilbert and I am the co-founder and managing director of Seattle-based Pioneer Square Labs, and our venture fund PSL Ventures.

David: And I'm David Rosenthal, and I am an angel investor based in San Francisco.

Ben: And we are your hosts. In 2018 we did an episode on the early-stage Seattle startup Rec Room. Founder and CEO, Nick Fajt, joined us at the time to talk about their seed round that they had raised from Sequoia. At that time, they were a popular app in this slow-to-develop VR landscape with a couple of 100,000 users and zero dollars in revenue.

Earlier today, Rec Room announced in the Wall Street Journal that they had raised $100 million at a $1.25 billion valuation from existing investors, Sequoia and Index Ventures. They are now a product that spans across many platforms from virtual reality, but also to Xbox, PlayStation, and iOS. They have had astonishing growth numbers over the last year, where they grew revenue 660% and now have over 15 million lifetime users, 2 million of which are creators on the platform.

David: Whoo, we knew them when.

Ben: Indeed. The background of all of this is that 2020 was a heck of a year for the entire metaverse category. You have Epic and Fortnite’s growth. they're currently rumored to be raising at a $28 billion valuation, and Roblox's blockbuster IPO that they pulled last December because there was too much demand, and instead raised private capital and then did their direct listing this month and are now valued at $40 billion.

David: The price was too high.

Ben: It was too high. You can say it's been a transformative year for Rec Room and the entire industry, to say the least. Today, we are back to tell part two of the Rec Room story, and again, with the best person in the world to join us, Nick Fajt. Nick, welcome back to Acquired.

Nick: Thanks for having me back. I'm excited to dive back in.

David: This is great. I think you are the first repeat guest on the main show.

Nick: Wow, all right, cool.

David: Love it.

Ben: Yeah, and over so many different stages of your company, I remember the premise of part one was how to raise your seed round with this guy we know who's raised it from Sequoia. He's got this cool company, and who knows about this very speculative space, and here you are a mature, grown-up company back to tell all of us how to do it.

Nick: It was just a straight line from those two points. There was no hardship in between, yes.

Ben: As it always is, especially in consumer entertainment, I'm sure. Well, listeners, are you an Acquired Slack member? If not, what have you been waiting for? It is a spectacular community discussing recent Acquired episodes, but more importantly, it's just a genuine and smart group of people having a thoughtful, nuanced, and respectful discussion about the tech and investing news of the day. Fun fact that I just learned is, one listener recently hired three other smart members of the Acquired community this month into his company directly from the Slack community. You can join at acquired.fm/slack

Now on to our presenting sponsor for all of season eight, Tiny. Today, we continue our interview miniseries with Jeremy at Tiny on building wonderful internet businesses. Jeremy, as you've built out the portfolio, how do you think about decision-making and the right level of interaction to have between Tiny and your portfolio companies, and why?

Jeremy: One thing we've learned from all the great kinds of conglomerate and holding companies is that they have really small head offices. They have that because they don't force synergies between their businesses. This is a lesson we've learned both from them but also from our own time as entrepreneurs, which is that generally, investors aren't as helpful as they tend to think they are. The way that we approach our companies is that we leave them alone. Our motto is, “We're not going to call you but if you call us, we'll pick up the phone and be as helpful as we can.” There are areas we can help with, which is usually recruiting and financing.

A big thing that we understand is that great CEOs and great leaders want to be left alone to run their business their own way. From everything that we've seen, that seems to be the best way to have a great portfolio of businesses versus trying to make them use one or another services or generally just kind of messing with them.

Ben: It's great. Thank you to Tiny. If you are contemplating a sale or even wonder what that might look like in the future, you should reach out, and just tell them that Ben and David from Acquired send you. You can learn more at tinycapital.com or by clicking the link in the show notes.

Lastly, I will keep this brief today. If you are not a limited partner, you should become one. We had a delightful LP call with so many of you last week and we're looking forward to more to come. You can join at acquired.fm/lp. We can't wait to see you there. David, Nick, let's dive in.

Nick: Let's do it. I'm ready.

David: Let's do it. As Ben said last, we left you guys the plucky Rec Room crew. It was February 2018, you'd raise this great seed round from Sequoia. You'd also raised an internal A from Sequoia that I think you didn't announce by then. Everything seemed to be great.

I was actually wondering before we get into what's happened since, we didn't talk as much about the real founding story of Rec Room back then. I was wondering if we could revisit it this time of how you guys actually came together out of Microsoft and started this company. It’ll be a really good context for entrepreneurs out there to understand. It may be that there's not always a big grand plan to become a billion-dollar company from the beginning.

Nick: The founding stories you normally hear are a very cleaned-up narrative of, I had this vision or I was doing this mundane tasks, and I this light bulb like went off. That was not true for us. I was working on HoloLens team at Microsoft, and I've been working on it for maybe four or five years, and it was right before the first headset launched. My team was really focused on consumer products for HoloLens, like video games. Essentially, like what kind of games are people going to play at HoloLens?

As the HoloLens team progressed it really shifted far away from consumers towards, let's shoot aliens in your living room, to let's help Boeing assemble jet engines. It really went enterprise and military, and it left my team that I was working with as kind of irrelevant. A bunch of us got reorg’d. We have this team, we all loved working together, and then the team got—

Ben: Where do you get reorg’d to?

Nick: I got reorg’d to the Microsoft Edge browser. It was so difficult because I've been working on the future for 4–5 years, and now I'm working on Microsoft’s second browser that I don't quite understand. What's wrong? Why can't we fix the first one? Why is there another one?

I found out I was moving over there and I was just so passionate about the AR and VR space, I wanted to stay in that space. As soon as I found out there was going to be a reorg, I actually applied to every company that was doing stuff. I applied to Oculus, I applied to Magic Leap, I applied to Google, I applied to Unreal or Epic, because I knew that their engine was focused on it. I got turned down everywhere. No one wanted to hire me. I have this valuable skill. Shouldn't somebody want to hire me?

David: Not even Magic Leap?

Nick: Magic Leap, not a fan, yeah. There were a couple other people that felt like I did. Shortly after this reorg, maybe 30–50 people left Microsoft and we're just like, I don't know what's next, but it's not going to be Groove music or it's not going to be the Calendar app.

Ben: To set some context, Microsoft had been experimenting with what would become the HoloLens for 7–8 years. It predated the work done on Oculus, right?

Nick: Yes. My first demo of HoloLens was in 2011, maybe.

Ben: Yes, super early.

Nick: Very, very early, and I have been working on it for years. When Microsoft first started it, they saw it as a successor to connect, and then over time, enterprise makes a lot more sense given the use cases we’re able to light up right now and expense. In Microsoft's defense, everything they did made a lot of sense. This was not ready to be a consumer product. It was way too expensive. The use cases that we could light up at the time just didn't make sense. Having a bunch of game devs focus on this didn't make any sense.

A bunch of the game devs left, a couple of them formed various companies that focused on VR, and Against Gravity happens to be one of them. Me and five other people came together to form a company called Against Gravity. To just give you an idea of how little of a plan there was, the reason the company wasn't called Rec Room was we didn't have the idea of Rec Room. We had no idea. We actually thought maybe we can leave and maybe Microsoft would let us keep developing stuff for HoloLens. We couldn't get a dev kit.

David: Not only did you not have the idea for Rec Room, you had no idea. The plan was just, we like working together, we're going to get together ,we're going to do something.

Ben: Yes, as I said, 30 or more people left. A bunch of them were like, I'm going to form this company, we're going to form that company. Against Gravity just happen to be one of those offshoots. The name Against Gravity, actually, is a demonstration of how little of a plan we had. The HoloLens headset internally was codenamed Gravity. It was so heavy, they were called Gravity A units, Gravity B units. We don't know what we're doing. We know we're moving away from that, and I guess we'll call it Against Gravity.

We were actually still very excited to go build HoloLens software. We just couldn't get a hold of a HoloLens. Some friends at Valve hooked us up with an HTC VIVE and we were like, okay, well, we got a piece of hardware, why don't we start messing around on this thing?

Ben: Wow.

David: That's so cool.

Nick: Honestly, all of us thought, oh, Microsoft will eventually get back in the consumer AR space and we'll just go back there, but in the interim will do this. I would say there was not a ton of intentionality there. It was more, maybe some egos were bruised, and I guess we’ll take a chance and try something different.

David: I’ve got to ask. We're going to tell the whole story about everything since your seed round and how you've gotten here. To sort of an analysis question up front, do you think that figuring things out as you went in those early days, has that served you well in getting here? Obviously, most other VR companies that were started around then are certainly not doing what you guys are doing or as well as you guys are doing. Or would you say, no, that was just how we started but things have changed?

Nick: It certainly gave the culture of the company a specific flavor. I wouldn't claim that it's the right choice, but it was our choice. It led the rest of Rec Room to have a very improvised style. We don't get too attached to ideas because there wasn't ever one early on that I think we were really, really attached to. We had seen some challenges at HoloLens about, we kind of all envision this metaverse world where maybe different people are authoring rooms and objects, and they all work together. We did see that problem. At HoloLens, there was an app that some people were working on. It was a travel app, like you go to Machu Picchu or the Colosseum.

David: I remember they’re doing that.

Nick: Yeah. There's another one, I think it was called HoloSkype. You can chat with somebody who is maybe hundreds of miles away, and it was really cool. There was a final one which I don't think many people saw. It was like a pet. It was like this little virtual dog. You can teach it tricks and stuff like that. But none of this work together. We couldn't be chatting on Skype, and then go to the Colosseum and then be like, let's let our pets run around the Coliseum. It was one at a time so you saw your pet, or you saw the Colosseum, or saw this person.

That kind of highlighted for us. There's something about the app model that doesn't work in this space. That got the gears turning a little bit, like maybe we could build a Wii Sports version of it. That was kind of express our idea. I would say there was definitely no grand, world-conquering plan. It was, how do we survive for a little while well?

Ben: Nick, just put a fine point on what you're articulating here, when you were saying that maybe the sort of app style doesn't work as well in this metaverse type world, can you help us understand what Rec Room is? For folks who didn't catch you the last time around, and maybe especially articulate this notion of it is just one big world. How did you come to that and what does it mean?

Nick: Very gradually, and I wouldn't say I came to it. I would say that there were many, many people on the team that contributed a lot of tiny choices that helped build where it is. Backing all the way up, Rec Room is a virtual universe. It's made up of millions of different rooms, and all these rooms are unique experiences. There are Battle Royale islands, there are escape rooms, there are fashion set shows. You can have a family reunion in Rec Room, you could have a book club, you could have a live performance of Hamilton. All of these things have been done.

Rec Room is just a very flexible environment where you can come together in a 3D world. Users get to build these rooms, and they can build and publish them. The way that they build is very unique. Rather than building in a game engine, you're just building kind of the way that you would in Minecraft. You're in the game, manipulating objects, and you can do it socially.

You can have up to 40 people in a room that are chatting with each other and talking about the room that they're creating. Maybe you want to build a Castle Crashers game. I could be like, Ben why don't you go build the moat, David go build a castle, and I'm going to work on the scoring and put a little goblin army over here. We can just have that creation experience together. It makes creation very accessible to people even if they don't know how to code, even if they don't know how to 3D model.

David: Unlike (say) Roblox—which we'll talk about more as we go—there's no separate creator app. It's all one world.

Nick: Yeah. Roblox has another app called Roblox Studio which is where you go and build. It kind of looks like Unity or Unreal, and it's a really powerful tool set. It does presuppose some knowledge like you understand scripting and what prefabs are. You might need to manage some network authority or something. Rec Room, you just kind of like building Minecraft style, and when you press publish, great, your room is now accessible on phones, PCs, Xboxes, PlayStations, and VR headsets. We’ll just host it for you and you don't submit to a cert body or anything like that.

It's like the Wikipedia of games. There's just a lot of people contributing to this world. New rooms are constantly popping to the top like a new hot list that people are discovering. You can follow creators to see what content they've created and get notified when they build new stuff.

Then, we've started letting users monetize in their rooms. We have an in-game currency that users can charge currency inside their rooms, and if they amass enough of a currency, we will actually pay them out for the currency.  We've got 14-, 15-year-old kids in there, who are earning $6000–$7000 a month in Rec Room. We're trying to scale that up. We think that can be a lot, lot bigger.

It just gives you an idea of the accessibility of the creation tools. It's really anyone can go in and realize the idea that's in their head, and they can really easily distribute it.

Ben: It shows up in the numbers. Classically, the internet was 100% of people consumed, and then 10% of people commented, and then 1% of people created. Those numbers haven't held exactly true for a long time as we've entered the social era, but that was sort of the old moniker.

You look at 2 million of the 15 million users that you have are creators on the platform, dramatically higher percentage since they're able to author right there in that environment. I'm cheating a little bit because you and I went in and played, and you showed me the maker pen, and I got to build my own little world. It's remarkably easy to use tools like that to create.

Nick: It's certainly a lot more accessible. If you're the generation that grew up living on the Internet, living in games, it's a very familiar medium for you to create.

Ben: Yes.

David: Yes.

Ben: Let's dive into the history here a little bit. You told me a moment ago that you publish across Xbox, iOS, and VR headsets. Last time we chatted you were just a VR Company. The VR boom didn't really arrive in the way that we were all sort of speculating and hoping. How did that affect you as a company? And how did the calculus of, hey, maybe we should have a contingency plan come about?

Nick: To give a recap—I think of the previous episode—we raised a seed round in 2016. We had launched the app and it was doing pretty well for a VR app. We were able to launch a seed round around that. Then a couple months later after working with our investors, we had a good track record of evolving the product and finding growth. We were able to raise an A-round from Sequoia as well, it's just the same investor that did the A. That happened about nine months later, and we were just keeping that secret as we planned out what was next.

When we chatted, we had just rounded out holiday 2017. We had seen a lot of growth. Probably from October to December 2017, the app 5X’d. We actually were doing really well. It was kind of a weird situation. We had all of this growth, but then we were looking out over 2018 and there are no headsets on the horizon. Are there any headsets in 2019? Normally, people are shipping us dev headsets 12 months at a time and they're like, hey, we're going to do this in the holidays and get ready. We just had nothing, we were like, this growth is good, but this is not a venture-scale business.

Ben: Your growth was basically capped by the number of VR headsets, right?

Nick: Yes.

Ben: You are a free app, so the majority of people who had a headset would go download. Basically, your growth was governed by the headset growth.

Nick: Oh, 100%. To give you an idea from December 2017, for the next 24 months, VR did not grow at all.

David: Your market, no growth. Zero percent growth.

Nick: Totally. We sobered up and realized it, January. Credit to the team. It would have been really easy to be like, oh, we just 5X’d. We're world beaters, we're amazing, keep doing that. It was, well, we just 5X’d and that's it. There's nothing on the horizon for us. This is dark days here. We need to figure out some path for more growth.

To that point we have been building all the content ourselves. Rec Room was a universe of rooms, but they were rooms that we were building, and there were only maybe 10 or 15 of them.We were good at building rooms. We really enjoyed it. It was really fun. We were building these little quests. We're like, you're gonna go battle space aliens with laser blasters, or you're going to take to the high seas and battle armies of skeletons. It's really fun. We were building these little contained rooms. Well, this is just not going to work anymore. We have to do something very dramatically different.

The two ideas that we seized on were that the community was so creative. The community was really bending and breaking Rec Room to do other things. We'd hear stories where people are like, oh, yes, I just invited a bunch of my friends to go play disc golf—we have a disc golf room. We just turned off the rule sets and we had a little picnic in the park. We're like, okay, that's it. Somebody else was having murder mystery parties in one of the rooms, they would just turn off the tool set.

David: Last we chatted, two people had actually gotten married in the Rec Room.

Nick: Yes, totally. There wasn't really the systematized, creative community. People are hacking the game to get it to do things that we hadn't intended. We're like, okay, well, what if we lean into this? What if instead of our rooms, it's their rooms? And what would it mean to embrace this creativity?

People are going through all these hoops to build these amazing murder mystery parties, but they can't save anything. If you're not in the room with the host, it doesn't work. What would it look like if they could set up a room and they could publish it, and other people go there and have that same experience even without the host? That was one of the big problems we started playing with.

Then the second was we've got to find growth outside of VR. There was an app called VRChat that had really started scaling around the same time. Outside of VR had really found this pretty devoted audience on PC. We're like, okay, it has worked for someone. Someone was able to find a marriage between VR and a flat app that works. That gives us confidence that we might be able to do it as well. We really started to like to lean into user-generated content and screens.

Ben: At least you went to iOS next, right? That was your first flat world experience?

Nick: Our first flat world experience was actually on Playstation and PC.

David: Because you had gotten a bunch of uptake from the PS VR. That was probably your big growth. That was 2017?

Nick: Yeah. PS VR was the big 2017 growth spurt. We're already on PS VR. What would it mean to make it work on PS VR without the headset? And the same question for PC. That summer, we did this big unveiling. Now you can have players from outside of VR. Now we're mixing in your rooms with our rooms. It was a dark day. The community was not happy about it. It was a big departure from what we were doing. There was a lot of hey, we want this to just be what it was. We don't want this to evolve in the way that you're doing this.

Ben: What was the downside to them of having someone not in a headset coming in?

Nick: A lot of the users who care deeply about headsets kind of is its own community itself. There probably was this bonding element of people coming in on headsets. You care about VR? I care about VR. This is great. We both care about VR. That is a magical thing that we want to preserve. We want to have VR rooms where these people that care about things can find people.

The big mistake we made out of the gate was we're just one big community. We're just going to dump everybody into the same rooms together regardless of interest or intent, and that was challenging. That was probably not the right move.

The other challenge was our user-generated content tools were really in their infancy. The rooms that people were building were not very high quality. Our belief was if we can shine enough light on them and they're in the right incentives, maybe eventually we can get them. The moment that we made the shift, it was probably pretty abrupt.

For two years, we were going to be really iterative, we're going to experiment in public, we're going to ship stuff, and we're not going to be embarrassed. We want feedback from the community. We probably realize that was probably some metabolism that the community can evolve at this speed. We probably pushed it too hard then.

David: This is right after we did our last episode. You guys are pretty deep in the trough of sorrow at this point, right?

Nick: Oh, yeah. From 2017 to all the way through 2019, no one wanted to do any VR stuff, but the VR users were very passionate. It was hard to explain to that group. Yes, we know you just want us to focus just on you, but if we want to keep serving you 10 years from now, we need to keep scaling this business.

Some people really understood. We weren't charging any money, so there was no revenue coming in. If you're a startup, you have two life bloods—it’s either revenue or growth. We don't have any revenue and we weren’t to find any growth in VR. We’re going to have to make this a $30 paid app which I don't think that serves anybody well, or we need to go find growth outside of VR.

Ben: Did you consider trying to get profitable, where you like, okay, if we were to turn on monetization, how long would it take to find something that worked? How much could we actually cover our burn and get to a zero net burn? Would our investors be on board with that? What does calculus look like when you're sort of examining that as a potential?

Nick: It's a reasonable question. Once we looked, the really bright spot for us was the user-generated content. This is gonna take a long time to make it click, but eventually if we can take these VR creators, if we can scale their creations and we can get them monetizing a user base that's at a mobile scale, they will be happy, we will be happy, this will be a really strong business with great network effects, very scalable.

If we just pivot hard towards going to try and extract the maximum number of dollars from the very limited number of users we have so that we're cash flow–neutral, we're just not heading along that path. We were just more comfortable that the promised land is really this user-generated content ecosystem, where we're rewarding our best creators for the amazing work that they're doing. That just looked different. I don’t know that we haven't really looked at it.

David: Were there example companies or products you guys were looking to as either an inspiration or a vision of what the promised land could look like? I'm wondering, were you looking at something like Instagram, if you can get this UGC flywheel going, or maybe even Roblox at that point in time which was starting to spin even though most of the rest of the world didn't know it yet?

Nick: Yeah. We were definitely aware of Roblox. We were looking at probably a lot of stuff on YouTube and Twitch. They have this creator class, they're able to reward the best of them. It creates really great incentives throughout the ecosystem where the platform's not pestering you for money all the time. You're really only rewarding the creators that you care about if you're a consumer. Then the creators are really acting as wonderful evangelists for your app. You shouldn't need to spend a whole bunch of money on marketing because you can have creator-led growth, basically. Twitch was a really interesting one for us to look at there.

David: When it actually happened might come a little later with when you introduced Rec tokens in the economy. One thing I know you guys did that I think is really interesting was incentivizing. You had this problem where you had this very passionate user base. You wanted new behaviors out of them. You thought they were capable of doing these new behaviors and doing them well, but you had to incentivize them to do it. If I'm getting it right, when you launched Rec tokens, you got Rec tokens for accomplishing specific actions that you guys set up in the environment, right?

Nick: Yeah. David's referencing a thing called Rec tokens which is basically the in-game currency that we use. You can use the in-game currency to buy things like kit out your avatar, you can buy shirts, hats, and gloves. You can also buy virtual food. We sell a lot of virtual food— rootbeer, pizzas, donuts, and stuff like that.

David: People are buying those both from you and from each other, right?

Nick: Yeah, and creators can charge for things inside their rooms. You could build a nightclub, a VIP lounge, and it costs some tokens to go in there, or fashion shows and different outfits cost different amounts of money, or maybe you're in some haunted mansion and creators are selling flashlights and light bulbs…

David: Or drink water in the desert.

Nick: Totally. People are doing all kinds of really interesting stuff with it; it's a pretty flexible system. If you look at where it is today, it went through a number of different stages of evolution to get to that point. For a while, we just had avatar items. You just did something good in the app—you leveled up, you made a friend, or some action we cared about—here's an item. We then started not going to give you items anymore. We’re going to give you currency instead and there's a store with the items.

You started getting used to like, I've got the currency, what I want to buy, and currency equals this much item. Then we unlocked an ability to buy the currency. Then we turned off the ability to earn the currency, except the ability for you to earn the currency then shifted to you can't earn it through leveling-up necessarily, but you can earn it through creation, so you can create something.

Ben: You can’t earn it from us, but you can earn it through other people finding value in what you do.

Nick: That's not entirely true. We do print a good amount of currency everyday to stimulate demand.

Ben: The little Rec Room Fed?

Nick: Yes, exactly. Quantitative easing in Rec Room. We do print an amount of currency as well because we do see behaviors we want to reward, which is probably a little bit more careful about the way that it works so that it's not an easy-to-game system. You can't create a thousand smurf accounts, horde the currency, and then move it around.

Ben: For people familiar with games, it sounds like what you had is you had only items, then you introduced a soft currency, then you took that soft currency, made it a soft and hard currency, and then made it basically an exclusively hard currency. Soft currency is currency you earn, hard currency is currency that you buy.

Nick: Yeah. If you looked at a gaming textbook of how to build an economy, Rec Room did all the wrong things. You should never be crossing the streams of your hard and your soft currency. You should never shift one to the other. I think we just had this idea of this is where we want to get to. Creators are making money. That's the end goal here. If that's Charizard, we're Charmander. How do we evolve into that thing?

Ben: Can I ask? This is a derivation but a team question. Once you realize you're going to do this and as you're doing it, are you like, we should have an economist at our company. Is it a PM? Who owns this?

David: Clearly not since he broke all the rules.

Nick: We really have focused pretty hard on having generalists tackle as many of our problems as possible. The team behind this, there's an amazing designer that had worked in mobile gaming for a while. There was an amazing dev lead that worked with me at HoloLens, him and her worked on this problem over probably two years. We have this economy that doesn't match at all the goal that we want. How do we keep evolving it? It was largely informed by our choice early on. Here's screen players, here's user-generated content. That did not work, it was too much, too fast.

For this one, they were like, what are the stages we need to go through, where the community will understand the incentives? They will be excited for each of the changes that we make. They were just really thoughtful about it and they carried it out very intentionally over the course of probably about two years.

Ben: Shifting to the creator side, what kind of behavior do you observe? Let's say I build a really successful haunted mansion and I'm selling flashlights. When do people decide to keep the Rec tokens that they've earned and when did they decide, this is a job for me and I'd like to make some cash on it?

Nick: It's probably a scale question. The currency is, I guess if you went to a thrift store and you were like, I'm going to trade-in some clothes, and I’m like, you can have this much of an in-store credit or this much in cash. It depends on what those numbers are.

David: Or GameStop, [...] currently.

Nick: GameStop, kind of the same deal. If you go in and you're like, we'll give you $60 or $300 in store credit at GameStop, you're probably like, I'm going to buy a couple more games. Give me the $300. If you add two zeros to the end of that, you can have $30,000 in in-store credit or $6000. You're like, well, $6000 sounds better.

David: Unless you want to be a real entrepreneur and start arbitraging, reselling. Honestly, it's kind of like a capital allocation question. If you're a creator, you’re like, how much do I want to pull out of this business versus keep reinvesting? Because they can distribute those tokens to their users by incentivizing behavior?

Nick: There's some element of that. They can basically place free gifts inside their rooms. They can pay for the gifts in advance and stuff like that to try and drive activity towards their rooms. It really comes down to what do you value and how much of this currency you have?

One of the classic game economy problems is you will end up with users who have so much currency, they can ruin your economy.

Ben: You mean like billionaires?

Nick: Yes. It's the same like a state tax sort of challenge. The problem that they run into is, these people get tired of the game because it's no fun anymore, I can buy everything. They'll just give their account to somebody else, and it'll ruin the game for that person then, too, because it's like the game genie has been turned on and now everything's free.

What we're trying to do was some of these users are going to have Scrooge McDuck-size piles of in-game currency. How do we pull that out of the system so that there are incentives to stay aligned with ours and they're not just dropping—

Ben: Like a fun name for a state tax?

Nick: No, we do not have…

Ben: It is fascinating, though. This is the first time I've heard of Rec tokens. David did a better job researching than I did. My mind is racing on all the ways that I could game this thing. I'm sure you very carefully consider—

David: Ben is going to acquire it and a new side gig is going to be scamming Rec Room.

Nick: I think you're going to see more of them in the games. They are fairly complicated to set up. There are a lot of things to be mindful of. You don't want to be a bank, you don't want to create a security, you want to adhere to know your customer laws and stuff like that. There is a lot of complexity behind the scenes. Also, there's a whole bunch of complexity for how do you ensure you're not getting scammed along the way here as well. That's why we have a fairly large team focused on that problem. To date, it's worked pretty well.

Ben: That's cool.

David: What are these three major, major things you figured out since our last episode of multi-platform, UGC flywheel, and creating this economy? What is the trajectory of the business and the company look like through this time? Obviously, you'd raised between the seed and the A, it was about $15 million from Sequoia, initially. How are you living during those troughs of sorrow years where you didn't have revenue coming in, fundraising more was probably going to be a challenge?

Nick: Again, going back to the roots of Rec Room, I don't think we had a normal founding story. I don't know that we had normal founding ambitions and I don't think the people that we hired were “startup people.” I don't think they were folks from the valley that spent two years at a place, got their options, and then bounced to the next, hopefully Facebook.

The people that we had hired to date are like, I love Rec Room, I love VR, I see the problem, I see the challenge that we're facing, and it's an interesting set of challenges. Because we had sort of an unconventional founding, we had hired kind of unconventional backgrounds that were like, I'm willing to see this through the likely tough times.

We had no attrition during this point at all, which was really cool. Nobody left, everybody understood the challenges. It’s painful getting yelled at by the community during these transitions, but we really do think it's in their best interest. We really do think if we want this thing to still be around in 5 or 10 years, we have to go do this stuff. It's worth getting some yelled at on Reddit if it means a couple of years from now, we can start having these creators earning a ton of money. That’s a really interesting world to go and live in, and it's worth a little bit of temporary pain.

Ben: When you say the temporary pain, if you think about the VR true believer—obviously, I'm going to flash us too far forward today—the Oculus Quest 2 is out, by all reports that's doing very well, we at PSL Ventures have a portfolio company, BigBox VR, with a game called POPULATION: ONE. It’s been phenomenally successful. I think you know Chia Chin, the CEO.

Nick: It’s a great game, yeah. They built a lot of good stuff. They built Smashbox.

Ben: Their engine is awesome.

Nick: They’re great.

Ben: Yeah. We could be at a little bit of an inflection point now where it’s too soon to tell, but VR could be here in a major consumer way. When you were thinking in the long-term best interest of these users who are VR die hards, were you thinking like, look, the long-term for Rec Room is we will be a VR thing. This is sort of the way that we survive in the meantime. Sure, it’ll be multi-platform forever now that we’ve taken the genie out of the bottle. Were you always thinking the end-all be-all will be VR?

Nick: I’ll put it this way. There were a bunch of companies in 2018 that had built VR things and then pivoted to, we’re not going to try and do cross-platform. VR is done. That was never a conversation for us. We really love VR. We really hope it’s a thing. There’s not a ton in our power to make it happen.

We certainly think of cheaper devices, with better marketing, and West cables that works a little better but do well. We don’t know and we can’t really affect that ourselves. We never talked about we’re just going to do a hard pivot out of VR. Even though almost everyone that I was chatting with in the VR space was just hard pivoting to this new app…

David: Enterprise SaaS, yeah.

Nick: Yeah, we’re just totally doing a totally different thing. We really wanted to see the VR journey through. We just knew if we exclusively focus on VR, either this is going to be a six-person team for two years while we wait, or we can go trying to find growth somewhere else through user-generated content and through other platforms.

We think we can actually ultimately build a much larger business that, at the end of the rainbow, it’ll have a much larger reward for VR users as well because it’ll mean if they create content, instead of reaching just VR users they can reach VR, Xbox, PlayStation, and iPhone. All of those users are potentially monetizable to them, so their reward can just be so much greater.

There were a lot of VR hardcore users that were like, I kind of didn’t like this to begin with, but there’s something nice about me just being able to hop into Rec Room really easily and not move my coffee table out of my way. I can just check and see if users are in there. I can just check on my room real fast. I can now do that.

Or, honestly because all the headsets were getting old, we had a lot of users that were like, my entire social life is in Rec Room. My controller’s broke and I can’t get [...] to fix them, but I can still hang out with my friends because I can still make it in here.

I think there are a lot of benefits that people started seeing from it. It definitely was not apparent when we first did it. I think there are a lot of people that are like, I don’t know that this is the right move.

David: There’s also another dynamic that I want to talk about that you explained to me a little bit ago that maybe we can talk about here. If you guys had said, we’re going to fork this. There’s going to be the VR version of Rec Room, and we’re also going to make the flat screen version of Rec Room. That would be fine, but what you can do even in a flat screen environment when your platform is architected for VR so much more, and you explained it to me so is the difference in a video game—in Street Fighter or whatever—you hit a button and you punch. In Rec Room, you punch, or you jump or whatever.

Nick: If you look at screen games, you look at mobile games, or you look at keyboard, mouse, or controller, generally the behaviors that your avatar can do are finite. They can jump, fight, pick up or place things. There is a finite number of them. There are N things that your player can do because there are an N combination of these buttons. For Rec Room, because we started in VR, the player actions were always infinite. Can somebody backflip? We can’t stop them. You’re wearing a headset, you do a backflip, that can happen. Can players lie down? Definitely. Can players juggle? Of course.

With the UGC system, we started seeing all of these rooms that were built around behaviors we had never anticipated, like this is an escape room, or you need to crawl under this thing, while crawling you need to pull out a lighter to light this candle. If we’re going to make this work on mobile or on a keyboard and mouse, we can’t have a ‘crawl plus whip out lighter’ button. That’s not going to work because we don’t know these things in advance. We just need to build an avatar that’s really, really flexible. You, as the controller of that marionette, need to be able to make this avatar do damn near anything.

I think it just led to a very different control scheme that you see in most games. The way that you can control your Rec Room character’s hands, you have independent control over left and right hands and you make them do a whole bunch of wild and weird things like dance, wave, all sorts of wild stuff.

David: Which is so different than almost everything out there like Fortnite. Fortnite’s great, it’s amazing, but you hit a button, you jump. You hit a button, you dance.

Ben: Well, yeah. What we’re getting at here is there was a reasonably easy path. Fork it, squash it down to 2D, and then use the same input system that works on iPhone games. Then, there’s a harder one that’s like, can we keep it all one world and let you do—I assume not all—a lot of the same flexibility from a screen that you can do in VR. I have to imagine that now that you’ve crossed that chasm and taken door number two, it pays off in all these ways of having a critical mass of people at all times in a single universe.

Nick: Totally. There were many false starts along the way. I think our original idea was let’s just jam all this into buttons. Then at some point it was like, oh my God we’ve got 40 buttons, alt buttons, shift and control buttons. I was really adamant that the game on screens be third person for a while.

That was an example of really bad design on my part because it made it really impossible for creators to build a world that was cohesive. Maybe they build an escape room in VR and they’re like, I played it in VR and it works in VR. Then you go in on screens and I was like, I need to pick up this Post-it note and read this really tiny writing. I can’t do that because I ’m in third person. That was a dumb move on my part.

Ben: But you can see what happened. I remember you were showing me. This was in early 2018. It was like, here’s the view. If you want to stream on Twitch, it goes to this third person view so that it’s not this I want to vomit because I ’m seeing through someone else’s headset. It’s a ‘third-party camera up behind me’ view. You can imagine we should translate that. You can see why you would want that to be the case.

Nick: That was my design contribution that probably wasted six months of dev time for somebody. If they’re listening now, I apologize to them.

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Nick, I have a question for you. This is based on what we were just talking about. Was it a consideration when you’re thinking about your currency? Like, wait a minute. Can we get cash on the balance sheet? Can we have a nice cash flow dynamic here from asking users to buy Rec tokens? Then maybe we don’t need to raise money as soon.

Nick: Basically treating this as a float?

Ben: Yup.

Nick: Honestly, the way that it played out is like when we first introduced the system. Still the majority of the currency was coming through our items. Basically, mostly what people are buying is government services. That wasn’t a huge consideration for us. You can see as more and more of our economy shifts from Rec Room–specific—we’re selling shirts to users selling shirts—you really do get a float on this.

The benefit of these kinds of ecosystems is it’s not so much the float. The real value is this is a much more scalable way of growing your revenue. It’s hard to grow your revenue by being, I am going to continually come up with new services and items, and every time I want to have a new hat or more hats, I need to hire more people over here. But if you build tools to let people do it, you just get a much more scalable catalog. In the beginning, it’s a much harder way to grow revenue. In the long-term it’s a much better way of growing revenue.

Ben: It’s fascinating.

David: Speaking of, by summer early December 2019, you’re seeing some green shoots.You’re starting to get through the trough of sorrow.

Ben: What are green shoots, David?

Nick: Green shoots?

David: Green shoots.

Nick: If I ’m going here, I ’m looking at our summer 2019 numbers, by that point screens had passed VR; there’s a larger audience. We have launched on mobile. Mobile was our fastest-growing audience, and VR was still doing well. It just hadn’t grown since 2017, at least in userbase. We grew a lot on the engagement side, but the userbase stayed around the same.

We found growth outside of VR, and we actually raised a Series B in April 2019. Largely, we took this VR Wii Sports, turned it into a cross-platform user-generated content platform, and we’re about to launch on mobile. That was the story for the Series B. I was showing people the mobile build and praying it wouldn’t crash. We had basically taken a PlayStation app and we’re going to run it on an iPhone. That should work fine, I guess.

Ben: Did Madrona lead that round, locally?

Nick: That was Index, actually.

Ben: That was Index?

Nick: That was Index, yeah.

David: That round was still kind of a story round, right?

Nick: Yeah. It would be interesting to ask them what their thesis on it was. I think the interesting thing that they were seeing was this is an app that has been around for years and it’s still growing. It’s taken some interesting turns. This user-generated content thing is clearly not what they were doing to begin with. This multi-platform thing, clearly not what they’ve been doing from the beginning, but both of them are working now. Maybe this team has more ways it can evolve.

I think it still was that story. At that point, our revenue was really de minimis. Our revenue was barely existent. I think we have one month of revenue. We made $20,000 in a month.

David: You had a 2021 revenue multiple under fundraise on that.

Nick: Yes, something like that.

David: Or a 2021 ERA of revenue multiple.

Nick: I think we were only monetizing one one platform. That might have been it. I think we were maybe only monetizing on Steam but not on PlayStation and other stuff. It started growing pretty quickly after that. We had interesting engagement numbers. We were soaking up a lot of minutes, but in terms of a business you really have to squint to see it, so kudos to Index for squinting pretty hard.

David: I want to ask you about this. Once you turned on monetization across all the platforms and the economy started to work, it seems pretty quickly after that the business became a really good business. You were generating a significant amount of revenue at pretty high margins, right?

Nick: Yeah, especially if you break out, like what’s fixed cost versus variable cost? The cost of supporting the service of Rec Room is relatively small. We need Wii services, we need Azure services, we need maybe this networking middleware, and then we need moderation teams. What’s that cost? All scales really nicely. Most software businesses is really, how much do you want to spend on R&D to ensure that you’re growing years down the line?

The business is growing really nicely. I think that there’s really, really interesting dynamics from the user-generated content side just because the revenue can grow really nicely without much input from us. We have slightly lower margin on that revenue versus us—

Ben: But you have to pay some of that out to creators.

Nick: Totally, but we’re happy to pay that out because those users are so valuable. They create so much value for us. They do such a good job of evangelizing [...], going and finding new users. I would rather spend money on that all day long than buy more ads on Instagram.

David: The two things I wanted highlight here that you just did is one, the beauty of this model is you don’t really need to spend too much of anything on user acquisition because, as you said, your creator led growth, the two creators that are creating amazing things, that are spreading the word about it, that are bringing in users, right?

Nick: Yeah. We started doing some paid advertising maybe two months ago. They were experimenting with it. I think there’s probably some number greater than zero where it makes sense. I think everyone who’s been in the venture game knows that performance marketing is you do not get economies of scale. In fact, it goes the other way. The more you’re spending, the worst each incremental dollar gets.

Ben: Like it’s me playing pinball. I put a quarter in every time and eventually, the ball goes to the bottom.

Nick: Yeah, except you run out of the good pinballs early.

Ben: Yeah. Somehow there’s worse and worse product/market fit with every additional pinball that gets loaded in.

Nick: Totally. Think about it. Let’s say you’re building a golf game on iOS that’s cartoony. The first couple of users you buy are like, I love cartoons and golf, and I have a phone.

David: This is exactly what I was looking for.

Nick: From then you’re like, okay well we’ve got all those users. Next up you’re like, you kind of like the PGA and maybe we can get you into this cartoon golf game because you golf in some way. Then you get all those users. Then Instagram’s like, well these users like being outside, I think, and maybe sports, and that’s kind of related.

David: It’s fun. Trust us.

Nick: Yeah, you’re paying incrementally more and more to attract these users that want your thing less and less. There’s definitely an amount that makes sense to spend in performance marketing, but this is how a lot of people get in trouble. They’re going to force performance marketing to work. The only force it’s to work is you spend on those users that don’t really want your thing.

With the creators, I would much rather pay creators more money and help them figure out like, okay here’s more money. Now your incentives just went up. Go find the sub-community that really vibes with the content you’ve created. They don’t need to even love every part of Rec Room. They just need to love the thing that you built, so we can have these kinds of sub-communities that are creator-led.

David: I love very specific parts of YouTube. They’re very different than I bet what you guys love, certainly what [...] loves. That’s great.

Nick: Yeah. I think Twitch does this really well. I think there’s a lot of different tones, styles, and personalities on there. They’ll go and find their people that makes sense for them. That’s what we want to happen and Rec Room as well. We want you to be able to build your little sub-community. And if you are a user, we want to help you find your tribe. When you come in, we want to help direct you towards the content that we think is most likely to light up your interests.

Ben: It’s very akin to the concept of marketplace liquidity. I remember a great realization that Dan Lewis opened me up to when we had him on for the Convoy episode. He’s like, the reason we need tons and tons of loads and tons and tons of truckers is because there is one trucker-load pair that is optimal, and then the further and further you get from that—literally physical distance—the worst of an economic deal it is for them because they’re going to have to drive to come pick up the load, they may not want to, it might be the wrong day. If we can get everyone on the platform, then we can always find the perfect match.

But when you’re subscale, you’re in this territory of, most of the time it’s probably suboptimal and it’s probably too expensive of a transaction. You can just see that playing out in the world of games where, I suppose the world of metaverse is where the more people there are on the platform and the more flexibility there is in the system, the more opportunity there is for people to find their tribe. That’s why the Internet is so great. There’s incredible marketplace liquidity on the Internet.

Nick: Yeah, and that’s the battle that’s about to be fought, is what is the long tail of your metaverse.

David: The other aspect that we’ve already touched on is while it’s probably not something you guys think about as actively, did you get a float out of this? The users buy tokens upfront, then they use Rec Room, and then they spend those tokens over time to creators who then over time either cast or either don’t, you guys are generating float. It’s the same deal with Roblox that hasn’t been covered enough about why people say Roblox is unprofitable. Their revenue numbers [...].

Nick: Roblox is very, very profitable, yeah.

David: Very, very cash flow generative. This is like all ships. Everything is slow and then fast. Last fall, you raised your Series C, right?

Nick: Yeah. In November, we raised a Series C. We raised $20 million from Madrona.

Ben: And that’s eight months into the pandemic?

Nick: That was eight months into the pandemic. The pandemic had definitely driven activity for Rec Room. The moment lockdown happened you can just see the jump. Rec Room started getting used for a lot more unusual non-gaming things during the pandemic. That was where we saw teachers teaching classes and their people holding group therapy sessions, people having family reunions. There were a lot more weddings happening in Rec Room. There are just a bunch of things that we were really excited about. It just showed the flexibility of the platform.

We did that raise in November. Then we launched on Xbox in December, and then Quest 2, back to the point about VR platform shoes and oversized denim jackets. It goes in and out of style, and it’s coming back into style.

Quest 2, Oculus, I have to give them props. They’ve built an amazing headset at an amazing price. They did a great job marketing it and we’re seeing amazing VR growth. I think that’s poised to continue as more and more people start jumping into that AR and VR world. It seems that’s likely to happen over the next couple of years. We’re really excited about that space.

Ben: Do you see the 660% growth in 2020 more attributable to, we have the best product/market fit on VR and there’s this incredible VR device now that sold well or is selling well. Where do you see it primarily attributable to, it’s the pandemic and people need a place to congregate that’s not the real world?

Nick: I don’t know that I can assign it to one variable. All these variables kind of clicked at once. We launch on Xbox and we were the number one free app on Xbox for several weeks around the holidays.

Ben: Didn’t you double your userbase in one week just by launching on Xbox?

Nick: Xbox was a huge amount of growth for us. We were really surprised by that. We didn’t really do any marketing. It was a pretty soft launch in terms of how much noise we made about it. There’s a lot of pent-up demand there. The mobile app was clicking and it’s been the fastest growing group. Then you see VR starting to take off, all the while the UGC ecosystem, you’re seeing great content getting built. We start paying creators and you just see all the incentives spend a little bit faster.

It’s kind of all these things kind of clicking at the same time. There is COVID also happening. If kids are only going to school for 2–3 hours a day, they have an additional couple of hours to play video games, and that’s largely what they’re doing with it. We saw all of these converging factors and business is doing very interesting things during the last months of the year here.

I guess the thing to take away from this—I would tell anybody else starting a company—is these are things that we started talking about in 2017. It’s 2021 and it’s not a miracle that needs to happen anymore. It’s a system that exists and now we need to optimize it. Very few things that are worth building can be built quickly.

David: You guys are ever a testament to that. We can get into whatever level detail you want but going from the whole dynamics, I imagine, must just have been so different going from, hey we need to raise money in the beginning to build this thing, to then we need to raise money, it’s still story we’re building this thing, that now you don’t need to raise money.

Case in point: a couple of months after your last raise, your insiders were like, let’s have a lot more money at a much higher valuation. What did that feel like? Did you see this transition coming in as a CEO, or has it been surprising as it kind of happened?

Nick: I think it’s definitely been surprising. The entire ride of Rec Room has been surprising. When I look back at what I was thinking during all of these different months in the past, I was wrong a lot. I was wrong all the time. I think the thing that we built was we built a really robust organism that could survive me being wrong a lot. That’s what Rec Room is.

I don’t need to be very right about what’s VR going to do this quarter because our business is independent of that. I don’t need to build the best room in Rec Room this quarter to drive growth because users are publishing 25,000–30,000 rooms a day. There’s plenty of content there and I don’t need to worry about what’s our next revenue generation tool because we’ve built tools for users to go figure that out; and they’re experimenting.

Then we were fundraising, there’s a lot of times where most of our fundraisers were just like, look we’re playing for time. We think we’re out in a point where we can fundraise and we think that the combination of the partner, the plan, and the price match up. We like the partner, we’re willing to enter into a marriage with this person. The plan for what we can go build with this money is interesting and has a possibility of inflecting the business. Then the price is a good risk-adjusted value for both the investor and us.

That was basically the calculus that we’ve done for every raise. We very rarely burned it down. I don’t think we ever burned it down. We have two months to live and if we don’t raise… We were always raising pretty far out from day zero.

Ben: I assume this fundraise felt very different.

Nick: This fundraiser did feel differently, yeah.

Ben: This was not like, hey it would be nice to have more cash. This was the first time you didn’t approach an investor but an investor approached you. Is it fair to say that? I mean, they’re insiders so they’re in constant communication.

Nick: That’s accurate. The dynamics of this round were really an internal gut check for us like, do we think we can build something that’s going to last for decades? If we are, what’s that plan look like? What does this look like as a standalone business? What is it going to take from a capital perspective to get this to a standalone business? If it’s really going to endure, what is the scale that it needs to get to? I think we just work backwards from there.

It’s going to take a lot of money, it’s going to take a lot of time, it’s going to take a lot more people than we have right now. If we can be patient about it, we think there’s a huge business that can be built here. It’s just going to take money and time.

We’ve seen what the oscillations of the market look like. We’ve seen the peaks of VR happiness. We’ve seen the trials of VR unhappiness. The same thing might happen here. Metaverses might be hot this year. They might trough next year for two years.

David: Roblox is a $40 billion company on the public markets today. A year ago it was a $4 billion company.

Nick: Yeah, you just don’t know, totally. This is our opportunity to untether ourselves from the emotions of the market and really take a long-term play here. I think that was really the question we ask ourselves. What does it look like for Rec Room to be 100–500 times bigger, 5 years from now, 10 years from now? What is it going to take?

Ben: I’m thinking a lot about listeners out there who have fundraised for their startups. There’s the deck and then on one of the later sides is the use of proceeds. You always say, here’s what we’re going to do with the money and then here’s the milestones we’re going to hit with the money. When you have a very different fundraise like this that is an offer coming to you, do you have to have a plan to use the money or is it okay to say, we may not spend all this money. We might go public with this much money in the bank still, and just like Zoom, that’s okay.

Nick: I can tell you, there are a lot of things about Rec Room that are probably idiosyncratic. There are many things that we did that I would probably advise others startups not to do. We’ve always been kind of vague around use of proceeds in past rounds because that’s the charm of Rec Room. There’s not really…

David: We’re making it up as we go along.

Nick: Totally. We kind of point to the past, like here are things that we thought we would do that we didn’t, and here are things that we never thought we would do that we did. I can make up a slide for you and show you what those things seem like today but know that these can change.

We were always upfront about that and I think it’s self-selective. There are some people that were like, this is bananas. What are you guys doing? This is your deck. This is crazy. I think other people were like, well this is a refreshing level of honesty because I ’ve been in enough board meetings to know that none of these plans survive contact with reality.

For this particular one, I think there was more conversation around how big do we think this thing can get. Realistically, what do we think the value of this thing can be. I basically write little notes to myself over the years, like here’s how I’m feeling on this day. Here’s what I ’m thinking.

When I look back, things always took longer than I thought, but they were always bigger than I thought. That was kind of like, if I could write one lesson for all the things that I was looking at over the years, I was always like, I wish this thing was happening faster. When it finally did happen, I was like, oh wow this is so much bigger. I know this is going to be a 50% increase. It’s a 10X increase.

Ben: You’re probably out ahead on an IRR basis even though it took longer.

Nick: Exactly. We don’t do a good job of thinking about [...] your growth like humans. This was an opportunity on how to protect myself against my own biases and inability to predict. We’re having a lot of money hiring great people, making it clear to them what the problems are and then stepping back. This money lets us do that.

It also puts you into a league that helps with recruiting in a lot of ways. There are certain dollar amounts, there are certain valuation amounts where you’re like, well, I’m not joining a startup that might not be here in a year, which I think is definitely a fear that many people in Seattle have. If you’re working at Amazon or Microsoft, any startup seems impossibly small, whether it’s two people or a hundred people.

This was one that we thought could help a lot of people in those bigger companies get comfort about, I’m going to join this company. It’s legit. It’s going to stay around for a while. But there’s still really taking risks and thinking big. We wanted to have it both ways. This allowed us to do that.

Ben: And you’re 60–70 people. Do I have that right?

Nick: We’re about 90 now. We’re hiring a lot.

Ben: Cool. David, do we want to move on to powers?

David: Yeah, that’s what I was thinking. Long-term listeners of the show obviously know we’re huge fans of Hamilton Helmer and 7 Powers. One thing we like to do when Ben and me analyze companies is we decide to go through the seven different powers that companies can have according to Hamilton, and identify which powers companies have. I don’t think we’ve ever done it live with a CEO before, but if you’re ready to be a guinea pig.

Nick: Sure. Go for it.

David: Let’s do it. The seven are counter positioning, scale economies, switching costs, network economies, process power, branding, and cornered resources. Maybe I’ll jump in first.

Ben: What’s funny David, we did that LP show on Roblox and I’m trying to remember exactly what I said there because I don’t see why it would be a lick different than this case. I know I argued fervently for something and I'm trying to remember what it was so I don’t contradict myself.

David: I know, we’re on the spot. I’m going to go first, selflessly to give Nick a break to think, selfishly to take the incredibly obvious one of network economies. It’s not just network economies, but it’s a network economy economy with the layer of Rec tokens in your own currency as well.

The way to think about network effects, network economies is as more users get added to the system, it grows value for all the other users in the system—great—but the thing about it is, there’s a multiplier. I’m thinking about an algebra equation. There’s a constant that you have to put in front of that value which is how much value does each incremental user generate.

Ben: A coefficient one might say.

David: What’s the coefficient, exactly. Thank you, Ben. What’s the coefficient? For something like Rec Room, the coefficient I think is actually really quite high because you have such a high conversion rate from user to creator. Once you become a creator, then that value that you’re adding back into the ecosystem—obviously, there’s a scale; some people adding tons of value, some people are adding little value—enables more super creators. That’s my thoughts.

Ben: How about I let Nick go next? He’s had a long time to think.

David: You just want to go last.

Nick: We talk about scale economies a lot, especially for our creators. The bigger Rec Room is, the more people you’re theoretically reaching, the higher your potential reward is. A viral hit in Rec Room is worth X today and we hope it’s a thousand X a couple years from now. If you’re a creator, you want to jump on these ecosystems early while they’re growing to try and get the value from that.

Now, it’s achievable for me to chart if I wait a while—maybe I won’t—and the value in the future will be so much greater. If I can get that positioning now, I can benefit from the scale later.

David: We should ask this before. Do you do any highlighting of creators to the user base?

Nick: 100%. We select featured rooms every week. I would say if you come into Rec Room you’ll see a mix of here is an algorithmically generated list and then here is an editorial list that’s selected by staff.

David: Are you looking for either in the algorithm or editorial, a combination of established creators that you know this stuff is awesome and new creators to keep constantly seeding the ecosystem and giving new people a chance?

Nick: A good example would be every quarter we run a contest. The last contest we ran was like Movie Magic, build a room around a concept of Movie Magic. It can be a scene from one of your favorite movies. It can have some cinematic flare to it or something like that. We actually do an in-game ceremony where the best horror room was this and you get to come up and take your trophy and give a little speech.

David: That is so awesome.

Nick: One of the ones that we highlight is the emerging creator who we never seen in a contest before that has really impressed us, because two contests later, those people are the masters of Rec Room tools. They’re teaching classes in Rec Room about how to use these tools and bend them to their will. We’re really on the lookout for that young nascent talent, for sure.

We’ve hired, actually. Quite a few people that have worked at Rec Room today were people that were in the community. We’re like, good God, they’re building amazing stuff. I wonder if they would come and give us feedback. The tools that we’re building will help us test them to make sure we’re not breaking them, or explain the way that the tools work to other players, like teaching classes in Rec Room. We keep an eye on it: (1) because it’s valuable for the ecosystem, and (2) it’s a great source of hiring.

Ben: The only last one that I was thinking about is do you guys think you have switching costs? Apple Podcast has switching costs over David and I. If we were to move and we’re done with podcasting, we’re going to be YouTubers now, we would never do that because we’ve sunked so much into this. Investment wise, it would take us years and years and years to rebuild not only the same audience but frankly understanding for the medium on something that’s not a podcast. Does the same happen to creators in Rec Room?

Nick: I think so. I think the way that you build in Rec Room is just so unique. It lets a group of people that otherwise can’t create, create. Every other tool like Unity, Unreal, or even Roblox Studio just feels really, really different from Rec Room. I think it’s hard to transfer those skills over.

That non-transferability, though, is also the thing that lets all those people who can otherwise create, create, especially once you build up your audience. You have tens of thousands of subscribers in Rec Room and they get notified every time you build a new room as well. There’s a cost to switching to another platform, or you maybe don’t have that audience, or you don’t have that notification engine.

David: We will be remiss if we didn’t at least ask you. I’m going to ask you first. Is there an element of counter positioning here versus Roblox relative to the age of your user base?

Nick: Remind me what counter positioning is?

David: Counter positioning is you are doing something in your product or business, that if your competitor, if you’re established entrenched [...] competitor, it would torpedo their business.

Ben: Or at least be value destructive to them such that it’s not economically worth them chasing you into the thing that you’re doing.

Nick: I don’t know if that’s true. I think Roblox definitely has a very young user base. I think they’re trying to grow up with that user base. I don’t know if there’s anything we’re doing that necessarily precludes them from doing that. We think of Rec Room as fairly distinct from Roblox. Roblox has sort of more of a two-sided marketplace where there’s two independent groups—creators and consumers. Those groups are separated by probably a 20-year age gap. There’s 9–12 year old players and then the creator base is probably mid-20s, -30s, mayber older. You’re coding. You’re using a game engine.

Rec Room just sits in between there. We’re like hey, we just want teens who basically want to play games or create games and you can do both of those in the same session. Instagram is very different from Photoshop. Photoshop has a more powerful toolset but the people that are looking at the content that are produced in Photoshop and the people that are working in Photoshop, it’s not the same group. But Instagram, it’s probably closer, like I can be a creator, I can be a consumer. Tools are pretty simple. I think we sit more in that category.

Ben: I love that analogy.

David: It’s funny, I thought you’re going to say the difference between Instagram and Facebook and the networks and the ages, but yeah, I like that analogy even better.

Ben: I want to jump into a section here—it’s an Acquired staple—what would have happened otherwise. This is an opportunity, Nick, if there’s any that you’re comfortable sharing with, is there any counterfactual that we should talk about? This could be that the company got acquired, or that the company got shut down, or you decided to sign some big partnership.

David: Is there a moment when history turned on a knife point?

Nick: I think the ones that probably jump out in my mind were, it was a very intentional choice. We could have buried our head in the sands with the VR thing and we were like, look, we’ve had success today. Every sign is pointing to this being problematic, but damn the torpedoes; full steam ahead. I think that would have been a really bad idea. We probably would run out of money in 2019.

I don’t need to come over the counterfactual for that one. There are other companies out there that have proved that for me. I’m really happy we made that choice. It was tough, though. That was really, really tough. That was tough for the community, it was tough for the team, too. The team is really sensitive to what the community thinks of Rec Room. It really means a lot to them. If ever make any changes where the community is not happy, I feel it in my stomach. I wake up with it every day. It really pains me. There were a couple of months of that for sure.

Ben: You are in a little bit of a Kobayashi Maru situation. If you had buried your head in the sand and gone VR, VR, VR, you would’ve died. If you had completely pivoted and been, we’re going to be an app, then you wouldn’t nearly have the power that you have today as a business, and you decided there is a door number three. We don’t have to pick between these two impossible; neither are good options.

Nick: Yeah. I think even when we were making that choice, we were like, are we just fooling ourselves to think that this is really going to work? So happy that we didn’t.

David: But you didn’t know along the way.

Nick: We definitely did not. At various points in Rec Room’s life when it has been harder to find growth or harder to find investment capital, we had chats with various folks about whether or not you never need to worry about financing again. Just come into the big warm arms of the big tech company and we can figure this out for you.

I don't know what that looks like. I think the moment that you accept that, you’re giving up your agenda for someone else’s agenda. It’s no longer our Rec Room, it’s no longer the community’s Rec Room. Some large company is buying it for a goal or an agenda that’s not ours. I think it really depends on what the company is to figure out if that aligns.

I would say, to date, we’ve never lined up like hey, we think this is in everyone’s best interest to join powers with this other thing. Actually, it’s been great. That was one of the things that really attracted us to this round. There isn’t a capital deficit that we need to go solve. We can just go build.

David: I was going to say, that’s one of the things that I hope in a few years when we all look back on this period in history, we may be laughing a little bit at the exuberance in the market that certainly lots of people talk about. I don't mean that I think your valuation is incredibly well- deserved and you’ve been on such a journey—

Nick: [...] the market talk right now. If you’re listening to this podcast and you think about raising money, now is not the worst time to do it.

David: Now is the time. I hope that this will be a really good, enduring outcome of it which is you don’t have to sell your company anymore. Things are working. Even if you think things can work in the future, you don’t have to ever sell because you can raise money in the private markets. That’s been true for a while. You can also be public now.

Ben and I have talked about this a bunch as a theme on the show, there are so many more $5–$20 billion tech companies out there and will be out there than anybody ever realized. Whereas I think before this era, it was like, okay great. You’re going to sell your company for a lot of money to a big tech company, or you’re going to be one of the very, very few that can be enduring, standalone, big business. I don't think that the economy exists anymore.

Ben: It’s a good point.

Nick: You’ve seen more consumer apps shift away from the advertising model. I think the advertising model really was there will be one. There are so many parties involved. Having a subscale ad business just sucks. You’re just going to have a bad business.

Ben: You’re going to have an inefficient place.

Nick: Yeah, and it’s a testament to what Google and Facebook built. Those are unassailable business. Having 1/10 of their scale is worth 1/100 of the value they have. That’s the Sisyphus pushing a boulder up a hill. You’re never going to make it. It’s just never going to happen for you. With more companies, especially on the consumer side going, we are not going to use an advertising model, it’s just going to be this different exchange of value, you can often build better businesses at smaller scales. They’re not as subject to a winner-take-all mentality.

I think that’s what you see in the gaming space. There’s a lot of very big profitable games. There’s not just one game. But it’s not as true in the social media space. There is one ring to rule them all.

Ben: That’s a really great point, especially as social media heads into the world of microtransactions and a little bit away from advertising. Assuming that the next generation of social media is VR and AR, then it’s very likely that there is going to be a direct supported model of the next platform where everyone spends time and interacts with each other.

Nick: I’m probably undereducated on this. My impression is that the market in China is less advertising-driven [...] and I’m curious to know how that affected the dynamics of does it create more room for smaller companies to shoot up?

Ben: Hard to say what the sheer number of people. There’s definitely a lot more medium-sized companies shooting up, to what to attribute is. It’s like your comment earlier. Five things are happening all at the same time and it’s hard to have attribution.

Before we move on, Nick, I want to ask you. One, I think because you’re a friend, I feel comfortable asking this on the show, but the warm embrace of a big company is a very rational decision for founding teams to make, particularly economically. Is there something you feel as you look at yourself or your co-founders from a personality characteristic where that actually probably played a role in us deciding to stay independent?

Nick: That’s a reasonable question. I guess I’ve never examined it as deeply as I should. The larger these things get, the more people that have incentives in these sort of decisions. At this point, I’m always trying to find choices that align well with the community that’s playing Rec Room, the people who are working at Rec Room, and the investors who have invested. I think the longer you go, the thing that got you here was betting on yourself. The thing that got you here was betting you could keep making it bigger and bigger.

When you come to those crossroads, you’re like well, hey, this thing has worked for me in the past. Do we take the chips off the table or do we double down? Doubling down has been the right choice for X long and it’s worked out for the parties involved. I think that’s the decision that we’ve got in comfort for X many rounds so far.

It’s not to say that we’ll never get comfort with maybe tying up with a big company, but I think we’ve been through enough good and bad that we’re like look, there could be bad coming and the bad could last for two years, but we know there’s going to be a bright spot on the other side, we won’t get demoralized, and we’ve seen the team hold together through those storms.

I don’t worry about it as much as maybe I did for a while. I think a lot of people worry like, oh everything we’ve built could disappear in six months. I definitely worried about that more in the early stages of the company where it feels like this could all disappear. I can’t believe we got here. Now that I’ve seen the team really persevere through some dark times, I’m like, okay, the engine that we have built has a lot of grit.

It just makes it tough. When you’re chatting with other companies then, they need to believe in what you’ve built more than you believe in what you’ve built to make the price work. That’s essentially what needs to happen. I’m pretty bullish. That’s just the challenge that you run into the longer you go.

Ben: Right. Thanks for answering that.

Nick: Sure. I did appropriately dodge your question.

Ben: No, it’s perfect. It’s great.

David: Budding public company CEO here. That was great.

Ben: That’s a great segue into the playbook. We’ve touched a lot of themes here that don’t need to be rehashed, but there is one that I really want to highlight here. I can’t say enough, at least my perception from the outside the value this creates, of one single world across platforms. You’re not creating a bunch of servers individually like Minecraft or something like that. You have a fluid economy and a fluid set of social experiences that are able to all happen in one single place.

Sure, you have rooms and rooms have limits, but it seems to me like we’ve touched on this idea of liquidity or of finding the perfect match between creator and someone experiencing something in Rec Room. I just wanted to pose this question back to you for how much gravitas I give that characteristic of your business. Do you feel that that’s as important as I’m drilling in here?

Nick: Like this is one cohesive world that’s like…

Ben: Yes.

Nick: I think it is really important. It’s the element that gives you brand. Every picture that anyone takes in Rec Room is recognizably Rec Room. It’s the element that gives you economic control.

People often will ask me, are you going to do anything with NFTs? A couple of years ago, ICOs were all the craze. Are you guys going to make cryptocurrency? My statement to a lot of people was, the value of those entities is that they are decentralized. That’s the value. The value that Rec Room derives out of its economy and its things is they are centralized. That’s the value.

We would be throwing that away for a buzzword. In fact, we don’t want decentralization. We want centralization. It’s paramount. If you think about the economic transition that I was telling you about, imagine going through that with cryptocurrency. You’ll never be able to do it.

Ben: Lobbying 50% plus of the community to be able to flip to your new [...].

Nick: I would be subject to whatever stupidity I put down on my white paper five years ago. I guess that’s the thing that I would tell most people. Maybe other people are really good at forecasting. I am not. We just face that decision head on. We’re like, how can we build optionality in the business so that when we’re wrong, we’re not trapped in a corner? Centralization in that one big role gives us a lot more control over being when we’re right and when we’re wrong. We have a lot more leverage to try and shift the game, or the economy, or the ranking algorithms that favor activities or actions we care about.

Ben: It makes a lot of sense. The other one I do think is worth just highlighting here—it so dramatically affected the trajectory of the business—is the realization you had that your growth was governed by someone else’s growth and by being captive to one platform and betting on that future to the extent that you make the decision to become a venture-funded business where the capital you’re taking is expensive and it is intended for ultra high growth businesses. You become a business that needs to go seek growth. I don’t want to put on you that capital was dictating that to you. I think that was a goal of yours, too, but it does strike me that there’s a lesson in there for other entrepreneurs where they can look and say, in the business that I’m starting, am I in control of my own growth or as my growth governed by someone else?

Nick: When we first started the company, I had never heard of a Series A round. I didn't know how you pitch to investors. Actually, probably, one of the best stories that I've got is Madrona who led our B round, I went to pitch them for a seed round. They were like, this was not very good, this is bad. I didn't make it to the next meeting and I emailed them back and was like, can I come back next week? I've worked on my pitch and they’re like, no, that's not how this works at all. I mean, that's how dumb was we were.

Ben: Was they, David?

Nick: They were not David. No, this is before I met David.

David: It was so funny because when Nick and I did meet later—I didn't know they talked to other folks—I told him this, oh man, this could be the same people, wait, we're talking about the same person here?

Nick: I think the learning curve was sharp. We just started at zero. Our first couple of interactions with ventures did not go very well. We were also looking for publishers. Publishers, if you're not familiar in the game space, they'll basically pay you per project. You're like, this is the project I’m going to work on, it's going to cost me $10 million to do this thing that I create. We’ll front the money.

David: You’re talking about Electronic Arts, Activision.

David: Yes, totally. There's a bunch. We’ll front you the money and we'll pay you for this very specific project, and at the end of the project we want to get paid back and then we want X% of the X’s Capital that this thing brings in.

That can be the right decision for a lot of games, but because of the way it's financed, it really does finance a very specific type of game. You are not going to build a services game that has an uncertain roadmap with that model because you have to know upfront, like two years from now I'm going to ship this thing. The moment it ships I have to step away because I actually can't finance it anymore. The publisher has only financed it for these two years.

That's where you get these disks that ship, and then the moment it’s out the door, you're like, we're on to the sequel for that thing because you have no way to finance the continued growth in iteration of the project. Even if you could, the economics are really not in your favor. You're probably splitting the revenue 50/50, maybe worse with the publisher.

David: Probably worse, yeah.

Ben: It's like a movie. It's like a band of contractors that comes together, has a budget, burns it down, then there's no more dollars left, and it's not like you could do anything, anyway.

Nick: Totally. As a result of interacting more and more with the venture space. A lot of people are like, well if you take venture dollars are going to be forced to grow. You’re more like, look, it’s a framework for thinking. The returns they're chasing are very specific and it will force you into a very specific way of looking at the world and making decisions, which is not a bad thing. It's just, you are going to swing for the fences. That's the game you're playing. It's about home runs not about bunts, not about singles. It's about home runs. You're playing Home Run Derby.

That's just the way to think about it. There are ways to finance any type of project. Just understand that if you have specific ambitions, venture can be right for you or it can be wrong for you, depending on what your goals are. We realized pretty quickly we don't have a two-year plan. We want to work on this for a long time. A publisher’s never going to be the right choice. Venture has to be the way we're financing it, and these are the things that they're going to expect in terms of growth and margin. How do we feed that back into the decision-making of, what is Rec Room going to look like?

Ben: I don't think anyone has ever articulated that as well as you just did on this show.

David: It actually is really, really good. The rabbit hole for one quick second because I think it's something really important there. People get a lot of cognitive dissonance looking at the venture market and financing, where they’re like, there's no plan. How did you guys have no plan to raise all this money? You need to plan.

But you had the key point there. If you're financing a project in the context of a movie or a traditional game studio went out, yeah, you need a plan. Because there's a set amount of money and you need a set of return on that afterwards. But that's not what venture is about. Venture is about the long-term, asymmetric, uncap-upside potential. Oftentimes, the way you can best realize that is exactly by not having a plan and by attempting like, oh shoot. The VR market dried up. What are we going to do? We got to find that growth. Well, we're gonna go to screens, et cetera.

Ben: Before we dive into grading—we talked with Nick about what the A scenario for Rec Room looks like over the next three years and ther scenarios—we'd like to thank Vouch, the official sponsor of the grading of season eight.

Vouch, as you know, provides business insurance for top startups. I had reached out to the co-founder of Vouch for coverage for Acquired. I think I've talked about this a few times as a business, since the founder’s a listener and member of the community. The experience was unbelievably good versus my previous experience. I’m looking at you both laughing at getting insurance for startups and what that process is like.

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Nick, the way we're going to do grading, since we're not grading a transaction here, is to speculate. What does the A scenario for Rec Room look like three years from now? I think there's an obvious F scenario. Those are less interesting because lots of numbers could go to zero, and anything multiplied by zero is bad. What's the B- scenario? What worries you, like stagnation or how does things sort of just plateau? But before we get there, let's talk about the A+. What in the world happens for this thing to just go gangbusters?

Nick: If you look at the video game space, there's a couple of video games that have transcended video games. They are part of popular culture—Minecraft, Fortnite, Roblox, Mario. Everybody knows what these things are. They have impacts well beyond gaming. I think that's what the A scenario for Rec Room is. We have grown into a space where Rec Room can have a positive impact well beyond gaming, it can have an impact on what digital entrepreneurship looks like, it can have an impact on what the future of digital events look like, what the future of the metaverse looks like.

That's the space that I'm most interested in. It's not really a financial outcome and it's not really a valuation, or we've IPO’d, or we've made X number of dollars. It's really like, what is the lasting impact that the brand and the product that we have built has beyond the gaming space? I think that's really what I focus on.

Ben: Will that primarily be attributed to this creator-led growth strategy going well?

Nick: I think it's probably how high up can we keep ramping those incentives for creators. Right now we're paying out X, and X buys us this style of creator spending this amount of time on their thing. If we can 2X that, do they quit their job and then focus on this exclusively? If we can 10X that, do they quit their job and convince five other people to quit their job and form a team to build this content? How high up that ladder can you build?

If your platform, the true test of whether your platform is are other people building a business on top of your business. You're only a platform if that's true. I think the question is how big is the business somebody could build on top of Rec Room?

Ben: Love it. And then the B-? What keeps you up at night? How could things just, hey, this is the top?

Nick: I think the B- is it's so easy to get complacent. It's so easy to be like, look at all the things that we've done. We crossed X. We defeated these challenges. If you spend too much time thinking about the battles you won, you don't want to be that guy that peaked in high school, and then stop talking about, like how they ran back some kickoff in their homecoming game. I think it's really easy to become that as a start-up where we’re like, we did this thing.

David: Yes, it is. It so is.

Nick: Yeah. It's especially challenging as you grow as well. Continuing to find people that want to push the boundaries of what's capable here, like keep taking ownership. I think the B- scenario for us is we get really content with patting ourselves on the back and being so proud of what we’ve done.

Anytime you’re raising money you have that temptation. I can view this as an endpoint. Look at the success that we’ve achieved. It’s this number or that number. Or you can view it as the game just started again. We just put all of our chips on the table; time to play. That's what we need to do to avoid that B- one. You got to keep experimenting. You got to keep growing.

Ben: I love it.

David: I love that.

Ben: All right. Carve outs. Nick.

Nick: Mine is someone sent me “Invent and Wander” which was a collection of writing from Bezos and it was organized by Walter Isaacson. It's Bezos over—I don't know—two decades. The consistency and the long-term thinking, you can just see it through the writings. This guy was writing about this in the late 90s and you're just seeing it play out today.

Looking at the writings of Bezos over a long period of time just gives me a new respect for the vision and the determination that that guy has exercised over just such a long period of time. It's really easy for people to forget. There was a decade when that business was the smaller, unloved stepchild of eBay, where eBay is the really good business.

Ben: eBay has the superior model to marketplace not the retailer.

David: High margin.

Nick: Yeah. I remember that. I remember nodding along, reading these articles, like, yeah, obviously, Amazon, how anachronistic? Managing your own inventory, that's crazy. If you look at what they built it in today, I think they just slogged it out over years, and years, and years. I think that's how many of the tech companies go.

For a long period of time people are like, this valuation is crazy. This doesn't make any sense. Why are people wasting my money? They don't make any money. To like, oh my God, it's way too powerful, shut it down. It's crazy how quick you can switch. I think it's clear Bezos has had this idea in his head the entire time, especially looking back at these old writings. It’s just very impressive.

David: It's awesome. Love it.

Ben: Add it to the list.

David: My carve out is so appropriate for this episode on so many levels. It is my new favorite YouTube channel called Resonant Arc. Have you heard of this Nick?

Nick: No, I haven't.

David: You’ll love it. They do a whole bunch of stuff on there. They’re obviously way better video production that we had at Acquired. They're somewhat so nerdy, super, super, super deep dives on video games. I'd sort of casually watched it for a while, but what got me so hooked was they just did a massive five-part series. Each episode is like three hours long about Final Fantasy 8, which, I remember I played as a kid the day it came out, and then played several times as an adult. If you played this game, you know it is a very controversial game unlike all the other Final Fantasies. These guys go to town, like 15–20 hours worth of content digging into this game. It's awesome.

Nick: Squall Leonhart, the main character, right?

David: Yes.

Nick: I remember Final Fantasy 8. All right.

David: I didn't realize it was the first Final Fantasy with a different director at the helm from all the previous ones, which is why I was so different.

Ben: The more you know. All right, mine is a YouTube video that I finally watched that I've had on my to-do list forever, and then I was catching up with someone who reminded me. It’s actually someone who listened to our Bitcoin episode and had some feedback. We were catching up and he reminded me, you should watch this video. It's called How The Economic Machine Works by Ray Dalio. Have any of you ever watched this?

Nick: No.

David: I think I maybe did a while back.

Ben: It's unbelievably succinct. It's unbelievably digestible at any level. You're both, four notches above the economic understanding necessary to understand this video, but it's basically a 30-minute primer on the economy. He's like, we got three big things that happen over time: One, you have productivity growth. Two, you have short-term debt cycles, and clearly we're experiencing that right now, you're always experiencing it. Then on top of that you've got the long term debt cycle.

He sort of explains recessions, depressions, all the different levers that the Fed has, that the government has, that wealth redistribution has, and when each of these different things are appropriate. It's just a crazy succinct way to understand, how does zoom out from our current conversation around, oh no, it's a bubble, and say like, well, actually what tends to happen over several hundred years out of an economy, especially ours here in the US. Where might we be in the combination of these three factors in our current one?

It’s old, too. It's from 2012 or something. It's not written for people pining to understand right now, which I think gives a little bit more authority. I highly recommend it. We’ll link it in the show notes. Well worth your time.

Well with that, Nick, thank you so much for joining us.

Nick: Thank you for having me.

Ben: What do you want to plug? What should listeners go check out?

Nick: Go check out, Rec Room.

David: We told you, you could have just made Rec Room your carved out.

Nick: Yes, go check it out. Send us feedback. The app is far from done. We're always interested in people's feedback.

Ben: Awesome. Well, Nick, we hope to have you back for part three someday. I don’t want to foreshadow what event that could even happen, but let's just say that in the far future.

David: Nick, What about if people want to get involved in Rec Room more deeply. What if they want to work with you? They want to get in touch with you? Partner with you guys, what's the best way to?

Nick: We are hiring, for sure. We would love it if you go to recroom.com. There's a bunch of jobs listed on there. There's new ones being posted every week. We would love to have you as part of the team. There's so much untapped potential, especially in the Pacific Northwest with the really, really big tech companies. You see that there's all the talent and startup ambition in the San Francisco space, and there's all the talent up in Seattle, but there's not as much of that spark. I think there's so many people at Microsoft, or at Amazon, or Google, or Facebook that would enjoy their life more.

Ben: Who is listening?

Nick: Yeah, who would enjoy their life more on the startup journey. I wouldn't want to lie with them. Higher highs, lower lows, but definitely a much more rewarding journey. When you're sitting at the end of a five-year journey and looking back, there's like a lot more. It will certainly make your life much more interesting.

Ben: I'll take it for Nick and I, both from Microsoft. This is another thing that Dan Lewis brought up during our Convoy episode—I just have to say one more time—you always overweight the risk of joining a startup. You always think, oh my gosh, this is so risky. Your downside is wildly capped, you could just go get your old job or probably a better one. If it goes well (God forbid), who knows what unforeseen doors that opens in your future?

Nick: For sure. I think when most people are calculating, like what is going to happen at a start-up or what is going to happen to me at Microsoft, they're using the law of averages. I just ask them, are you average? You think you are an average person?

David: That is some serious Jiu-Jitsu. Wow, I love it.

Nick: Look, I think the math makes a lot of sense. If you feel like you're going to be subject to that law of averages and you're going to score in the middle—like Microsoft's a great spot—if you do think you're in the top 25 or the top 10%, your upsides really capped at Microsoft. There is only so fast you can grow there. There's only so much responsibility you can get over such a short period of time.

That's not true at startups. If you really feel your career is capped in some way, I tell people the risk is really worth it. You really can't find a lot more responsibility, a lot more ownership, and have a lot more impact on a product.

David: Ben and I would be remiss if we didn't also throw in, also applies to starting a company for most people.

Nick: Totally, totally. Yes.

David: I’m sorry, Nick.

Nick: No, no, go for it.

David: If you don't start a company, go work at Rec Room.

Nick: Exactly. I think I may need to go back to Bezos. The regret minimization function that he uses which is like, hey, when I'm looking at any decision and I think about what am I going to feel in five years when I look back on this choice, people tend to regret the decisions that they didn't jump at, not the ones that they let pass.

Ben: Yes.

David: Totally.

Ben: It's a great framework. You're stealing all these future potential carve-outs.

All right listeners. We’re going to wrap up here. We told you about the Slack. Go check it out acquired.fm/slack. We’ll be talking about this episode. If you want to be an LP, that’s at acquired.fm/lp, and you should. Frankly, if you are not subscribed or soon to be called following—as we are finding out, subscribe is going to be a reserved word for paid podcasts and following is what happens when you free podcasts—you should follow us from your favorite podcast player. If you liked this episode, you have a friend or co-worker that you think, hey, I thought of them during this episode, share it with them. We would love to have them join the Acquired community.

With that, thank you to Nick, Tiny, Cap Chase, and Vouch, and we will see you next time.

David: See you next time.

Nick: See you.

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