Avalon Ventures Founder Says FarmVille Creator Zynga Could Be Best Bet in 27 Years

5/10/10Follow @bvbigelow

Last week, San Diego’s Avalon Ventures confirmed that it is setting out to raise its ninth venture fund, which is expected to close between $150 million and $200 million. That’s a modest fund by the billion-dollar standards of Sequoia Capital or New Enterprise Associates, but it’s a formula that has worked well in the 27 years since founder Kevin Kinsella started the boutique firm, which specializes in seed and early stage investments in promising startups.

Kinsella tells me securities law precludes him from discussing Avalon’s ninth fund. But he was willing to discuss other matters, and he notes that Zynga, the San Francisco-based maker of multiplayer browser games like FarmVille and Mafia Wars, is the standout investment of Avalon’s current fund, which is something some media reports overlooked. It seemed like a good idea, especially since Zynga is the subject of intensifying media attention in Silicon Valley because of its reported rift with Facebook. Today, reports are flying that Zynga plans to establish its own gamers network at Zynga Live.com.

Kinsella says Avalon invested $5.3 million in Zynga in late 2007, a relatively small stake in a startup that has received roughly $219 million in venture capital. Nevertheless, in regulatory papers related to a new financing that Zynga filed in April, Zynga’s implied value is now close to $4.6 billion—and Kinsella says Avalon’s investment in Zynga may rank as the venture firm’s single most successful deal.

“It is among the most successful, for sure,” Kinsella says. “I would have to go and look. We had some early funds in Avalon that had what we call MOICs—Multiples Of Invested Capital—that were in the hundreds, and Zynga is approaching that and still growing…When all is said and done, it would not at all surprise me if it were the best investment that Avalon has made in the past 27 years.”

Kinsella also explains that the financing revealed in Zynga’s recent filing (Zynga issued almost 2 million in preferred shares related to a new investor that some speculate is Japan’s Softbank) as well as a reported $180 million investment several months ago by Russian venture investor Digital Sky Technologies allowed early investors to take some money off the table. “Not all went into the coffers of the company, because as you can imagine with a company with the revenue base growing the way it is [More on this below] with no cost of goods sold, they don’t really need any capital. So this is providing an alternative liquidity event scenario for some of employees and some early investors.”

When I asked Kinsella how did the deal came about, he gave a long explanation that’s worth repeating in its entirety:

“This is a company that we invested in because Rich Levandov, who is our East Coast tech partner in Boston, knew the entrepreneur, Mark Pincus. This is the way we get a lot of deals. Again it reflects on the way we do business at Avalon, our catechism, because we are a principals-only firm. We don’t have associates. That contact with entrepreneurs is at a partner level, so we’re not torturing someone with a bureaucracy of assistant associates, associates, venture partners, junior partners, partners, and the sun god. And entrepreneurs appreciate that, because they want a yes or no answer pretty quickly.

“Mark had actually tried to hire Rich in the mid ’90s for a company he was starting at the time. Rich was at AOL, and he passed on the opportunity, but they stayed in touch. So when Mark came up with this other opportunity, which was Zynga, it just sounded like it was going to fit right because it was an opportunity to use the social networking platforms to enable people to play games between and among their friends, which was not possible before. You could get online and play backgammon with strangers for the [previous] decade, or chess or something, as long as the Internet was around.”

Zynga was an appealing deal because it created a structure whereby your friends can help you, Kinsella says. “In fact, in order to get help, you have to enlist your friends, which is part of the magic of Zynga which is why people are invited to give turnips or whatever it happens to be.”

Today, Zynga is the hottest social game publisher on Facebook, with an estimated 235 million active monthly users for such games as Texas HoldEm Poker, FarmVille, and Café World. After I talked with Kinsella last week, Michael Arrington reported on TechCrunch that tensions have emerged in the relationship between Facebook and Zynga, largely because Facebook takes a reported 30 percent of the money that Zynga users spend to buy virtual stuff for their online games.

As a private company, Zynga doesn’t disclose its revenue.But they are substantial, with estimates ranging from $270 million in 2009 to as much as $600 million, according to Jeremy Liew of Lightspeed Venture Partners. The revenue growth at Zynga has been phenomenal, according to Kinsella, who says Zynga is “the fastest-growing company in terms of revenue in the history of the Internet.”

He would not discuss specific numbers, but he explains that 3 to 5 percent of Zynga’s players actually pay real money to buy virtual goods that are available on the site. Players can buy a tractor for their farm in FarmVille, which enables them to farm faster, or a more powerful weapon in Mafia Wars, or you can buy more poker chips to bluff your opponents in TexasHoldEm. “Now if you multiply small amounts times 3 to 5 percent times 235 million users, you know, pretty soon that’s real money,” Kinsella says.

farmvilleSome observers might shake their heads and ask why players would pay real money for virtual goods. Kinsella says, “Think about it. There are a lot of things that we do in the quote real world that are kind of virtual, if you will. For example, you send someone a birthday card. They read it, they laugh, they throw it away in the trash. That’s not a lasting gift that you’ve given someone. Flowers, for example, they wilt. So there are real-world things that you’re willing to pay a value for that are in the ones and twos, three, four, five dollars. It’s a nice gesture; it’s the right thing to do; it’s a nice thank you; whatever. But you do not expect that it’s going to have any great significance to the recipient. Virtual goods are kind of the same way, except there is literally no cost of the goods sold.”

Bruce V. Bigelow is the editor of Xconomy San Diego. You can e-mail him at bbigelow@xconomy.com or call (619) 669-8788 Follow @bvbigelow

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