New Reality for U.S. Venture Capital: Data Shows Startup Deals Are Smaller, More Numerous and More Capital-Efficient

10/15/10Follow @bvbigelow

The MoneyTree Report on third-quarter venture funding echoes results that we reported earlier this week, showing $4.8 billion was invested in 780 venture deals nationwide.

That was a 7 percent decline in venture capital invested—but a nearly 9 percent increase in the number of deals—compared with the same quarter in 2009, when almost $5.2 billion was invested in 716 deals, according to the MoneyTree Report, which is prepared each quarter by PricewaterhouseCoopers and the National Venture Capital Association, using data from Thomson Reuters.

The MoneyTree numbers vary from the figures we reported Wednesday from CB Insights, the New York information services firm that found $5.4 billion went in 715 venture deals nationwide during the recent quarter. The numbers don’t match because the surveys use different methodologies. But what’s noteworthy is that both reports show similar trends—an increasing number of smaller venture deals, and a surge in venture funding for early stage deals.

Michael Greeley of Boston’s Flybridge Capital Partners says that’s good news for startups, and he offered some insightful observations during a conference call with reporters yesterday.

“The amount of first-time financings is a great barometer for the health of the industry,” Greeley said. “That really is probably the most risky investment that venture capitalists are asked to make. To see that over a quarter of those dollars went into those types of companies, I think was quite, quite encouraging. We also shouldn’t lose sight of the fact that July and August are historically pretty slow months.”

Of the 780 deals funded during the third quarter, the MoneyTree Report says 271 (35 percent) were early stage financings—including 87 (11 percent) first-time investments, which are often described as seed-stage deals. Of the $4.8 billion total invested, almost $1.3 billion (about 26 percent) was invested in such early stage deals, according to the MoneyTree Report.

Greeley also offered some other interesting observations on venture investing during the quarter:

—Several factors appear to be contributing to a decline of VC dollars that are actually invested, including an industry-wide downsizing in the number of active venture firms, smaller individual fund sizes, and a new focus on investing in more capital-efficient business models. “We have an industry that is being rationalized, consolidating,” Greeley said. “So naturally, I think you’ll see fewer investments being made in that type of environment.” Smaller rounds simply reflect “the fact that we’re funding more capital-efficient models,” Greeley said. “Certainly in the consumer Internet, those companies just require less capital, and frankly, that’s a great thing as an investor.”

—While the $4.8 billion in venture capital invested during the third quarter was down 31 percent from the $6.9 billion in VC dollars that were invested during the prior quarter, Greeley said it’s generally in line with the previous seven quarters. It’s also probably one of the first quarters when the amount invested was more than that raised by U.S. venture capital firms (nearly $3 billion) during the quarter. “I think you can look at that and say it augurs well for the venture community, in that you’re sort of burning off the overhang,” Greeley said.

—Mergers and acquisitions continue to make up most of the exits by venture-backed startups, and Greeley said, “The IPO market clearly is still is on its back.” Many venture capitalists are now willing to consider buyout offers in the $150 million to $250 million range that they would have spurned five years ago (while at the same time asking themselves if they can still make outsize returns). That means that venture firms are structuring their financings differently, Greeley said. Instead of providing $20 million to a startup, Greeley said VCs might provide less overall funding. The initial financing might be just $5 million, with additional tranches dependent on the company growing revenue and achieving specific milestones. But he sees good things happening as a result. “My sense is that the CEOs and entrepreneurs that we’re backing have a higher level of confidence that they can go to market and raise capital on reasonable if not attractive terms,” Greeley said. “The last couple of years have been a bit of a falling knife in terms of financings, and that’s clearly not the case any more. There’s a level of predictability. Companies that are showing growth and hitting milestones are able to access the venture capital markets.”

—Greeley anticipates an increase in M&A activity, partly because buyout activity has picked up in recent months, as exemplified by IBM’s $1.7 billion acquisition of Netezza in September. He noted that the 15 biggest technology companies, including Cisco, Google, and Microsoft, collectively have a total of roughly $316 billion in available cash. As Greeley put it, “There just seems to be this sense that there’s this impending wave of acquisitions.”

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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