Is virtual reality a bubble? That’s a common question in a number of panels I’ve covered in the past year. The answer isn’t quite knowable until a major event comes along that either expands or pops the bubble. Digi-Capital reported that venture capitalists invested $500 million in augmented reality and VR during the third quarter, with 65 percent of that money coming from mainstream traditional VCs. At that rate, VR is consuming a measurable part of VC investments in the world. Digi-Capital estimates AR and VR could be a $120 billion business by 2020.

To get some insight into those numbers, I moderated a panel on investing in virtual reality and augmented reality at Greenlight Insights’ recent Virtual Reality Strategy conference in San Francisco.

The panel included Toby Zhang, cofounder of the Youku Global Media Fund, a joint early stage venture fund between CRCM and Youku. It focuses on media, AR/VR, and A.I. Our second speaker was Marco DeMiroz, partner at the $50 million Venture Reality Fund, which focuses on VR, augmented reality, and mixed reality. And it also included Michael Yang, managing director at Comcast Ventures in the Bay Area.

Here’s an edited transcript of our conversation.

VR investors Marco Demiroz (left), Toby Zhang, and Michael Yang.

Above: VR investors Marco DeMiroz (left), Toby Zhang, and Michael Yang.

Image Credit: Dean Takahashi

Toby Zhang: I’m a partner with Youku Global Media Fund and CRCM in San Francisco. Most recently we launched a frontier technology fund investing actively in VR and AI. It’s a joint venture with Youku. We’re looking very actively in the space, in the U.S. and in China as well. I hope I can share some insights from what we’ve seen overseas. It’s a very new and interesting area for us.

Marco DeMiroz: My partner and I quit our jobs and thought we had a once in a lifetime opportunity to invest in VR, AR, and MR. It’s a $50 million fund. We’re very actively investing in the space. Currently we have 14 companies in the portfolio, and we’ll probably end the year with close to 20.

Michael Yang: I’m a managing director with Comcast Ventures, based here in the Bay Area. I lead our VR, AR, and MR investing efforts among other categories we invest in as a multi-sector, multi-stage fund. We’re the direct investment vehicle for Comcast corporation. We’ve been around for 17 years. We’ve invested in seven VR and AR companies, including some with Marco’s fund.

GamesBeat: Marco, how many panels like this have you been on?

DeMiroz: It’s kind of become the Michael and Marco show, yeah. We’re not a YouTube hit yet or anything like that, but in the last month or so we’ve done three together. Part of the challenge, and maybe the opportunity as well, is there’s still a very small number of traditional venture funds and venture investors in the sector. Obviously Youku is a corporate investor with great distribution capability and strategic benefits.

For us to continue to work with the traditional venture community and expand that circle — as you said, like 60 percent of recent investment came from traditional funds. Part of the reason this is happening, companies that saw investment early on are now raising their traditional A and B rounds. Our recommendation to them is to go and get a lead from a traditional venture fund, so you can have price credibility. You have a partner who’ll be patient and persistent and stay with you for a long time.

We’re very interested in expanding the circle, but for a while it’ll be the Marco, Michael, and Toby show. Then hopefully we’ll see other groups joining us.

GamesBeat: Michael, where are you stepping in compared to someone who’s very early stage?

Yang: Of the seven investments we’ve done, we’ve led three of them. Of those three, two were series A and one was a C. The other four we’ve participated in have been either series A or a seed round. Frankly, there is no mid-stage or late-stage opportunity as yet, given the nascency of the business. If you want to participate, you either jump in with both feet or continue to sit on the sidelines.

As much as we all love Tim [Merel] over at Digi-Capital, I have a hard time reconciling his data. I don’t see the same trends he does as far as mainstream Sandhill Road venture capitalists coming in.

The Oculus Touch controls let you navigate independently with each hand in VR.

Above: The Oculus Touch controls let you navigate independently with each hand in VR.

Image Credit: Oculus

GamesBeat: If you take [big transactions] out for [the data in the past year] and see what everything else looks like, maybe you get a better picture?

DeMiroz: Yeah, I think he has a little exuberance in his numbers. But fundamentally, the current run rate is about five percent of U.S. venture capital investments. The U.S. normally does about $50 billion a year, more or less, in a traditional market. If we’re talking about a $2 billion to 2.5 billion a year run rate — like you said, about a year and a half ago, from a venture fund perspective, it was a very small percentage. Now we’re up to five percent. [Correction: The $2 billion a year refers to global VR investment numbers, while the $50 billion U.S. figure is a subset of the global investment number, so the percentage stated is not accurate].

From our perspective, it’s much better for the sector to have these venture funds beyond Comcast. Others need to follow their lead and come into the market, not only to establish price credibility, but also to provide persistent and patient capital for these companies to grow.

Zhang: Looking back over the past year and a half to where we are today, things have definitely shifted. VR was very hyped for a while. Money has flown in both from the west coast of the U.S. and the east coast in China. Valuations are a little higher than in traditional venture areas. But things have calmed down a bit this year. We’ve seen prices and valuations start to normalize. Looking forward, we’re going to keep observing this trend.

From an investor’s perspective, we’re looking for more than just a great business model or great technology. A company needs to have both. It needs to have a strategy to survive. The VR market is a very exciting new trend, but if it doesn’t take off as fast as everyone hopes, does a company have a way to continue to grow and get to a stable business? That’s what we’re looking for now.

GamesBeat: Now that all the hardware has launched, you guys get to look at some of the results that are coming in for some of your portfolio companies. Are you encouraged by what you see? Not just in terms of units in the market, but are companies starting to generate revenue?

Yang: I’m encouraged that all the major technology players have headsets either announced or on the market. That’s great. A lot of people ask why we’re interested in VR. Well, when was the last time you had so many global technology titans all piling in to one sector? They’re investing far more than the venture capital universe will ever contribute to this. It’s a great battle in front of us.

We have to be careful that we don’t invest in things that these guys stomp on. They all have very immature platforms. They all have major deficiencies and gaps. Those are all very well-known. They’re working on them. We often hear startups working on middleware, middle-of-the-stack opportunities. To me that gets squishy. Ultimately your go-to-market is either OEMing it or licensing it to the platforms. Sure, there are a dozen or so of them globally, but it’s not a great place to be. You’re just setting yourself up to be acquired.

We’re not choosing that. You either go all the way at the bottom of the stack or you go all the way to the top. For us, as much as people think it just makes sense for us to invest in content and apps and all that — we’re a media company, after all — we have at least in this year and a half seen a lot more investor support globally for things like apps and content. That might be a temporal thing, meaning there was a window of opportunity when you could invest against that thesis, but that doesn’t mean it’s a consistent, long-term investment thesis.

Back to Toby’s comment earlier, the bar has risen. What we would have invested against last year we won’t this year, and we definitely won’t next year. Now that we all have portfolio, we know what the best can do in our portfolio. Those are the thresholds we’re looking for.

DeMiroz: The trends are encouraging in the sense that — we’ve been monitoring Steam dynamics in the first four months. Cumulative revenues were about $20 million and ramping up. Sometimes you have to look at the data, what the world tells you, but early adopter behavior may not be sustained behavior. A lot of the time the price dynamics we can extract from app stores right now won’t indicate what will happen three years from now.

There are bold platforms out there. Microsoft’s announcement for next year, with inside out positional tracking and so forth, that’s the direction we’re heading. We need our portfolio companies to have a multiplatform or platform-agnostic strategy and start executing, getting some data. All of our guidance to them has said, “Don’t have a long product development cycle. Get out there, get on multiple platforms, iterate like crazy, and continue to improve.” The early behavior model is not going to indicate what might happen later on.

Zhang: Multiplatform, multiple form factors, that’s very important. One thing we’re also wanting to add is going into the mobile space. With what’s going on from Project Tango and Microsoft, there are definitely big players in this space. We need to grow and bring AR and VR into the mobile space. We’re paying close attention to this in startups. We want to make sure that, as a young startup, you’re not just positioned for the tethered experience, but also have a complementary or compatible mobile strategy. As the mobile market grows for AR and VR, startups need to be ready to make that transition and be present.

Pixvana lets you capture scenes in VR.

Above: Pixvana lets you capture scenes in VR.

Image Credit: Pixvana

DeMiroz: Mobile VR is going to be huge. I’m generally an optimist, of course. But it has to be very convenient. I can understand people having an HMD in their home and another HMD in their office. Aside from that, you need a form factor that you can carry with you. I had a phone case with built-in lenses, where you could flip a button and consume VR content. Hopefully that’s where we’re heading with mobile VR.

What’s happened in the U.S., in the summer of 2011 we reached 100 million smartphone users. At that point the economic model shifted from premium to freemium. You had a critical mass of users to sustain a freemium economy. By the end of 2011 the freemium money exceeded premium money. That’s where we need to go.

We see a lot of innovation coming from Chinese hardware manufacturers when it comes to very small form factors. If you go to Alibaba and do a search for “HMD,” you’ll see prices from $4 to $14. These are quality lenses. Some of them are super portable. But that’s what we need for mobile VR to take off.

Question: What’s holding back financial investors?

Yang: Most firms have one proponent of VR as an investor. One guy who’s a fan. Then there’s a lot of other partners who are highly skeptical. Unless you’re in a two-man shop where you only have to convince one other person, you have to go around and do a lot of politicking to convince your colleagues. You have to pick your battles as far as which things you want to try and push over the goal line. That’s why more traditional funds — really you only see one investment, maybe two in the portfolio. Unless you’re a dedicated fund or a really big believer or have a particular mandate, you’re not going to see more at this juncture.