Canaan Strings Together Some Good News, Just as the Pressure Mounts on VC Model

3/24/11Follow @xconomy

Every time I walk into a venture capitalist’s office these days, I essentially ask a polite but pointed variation of the same question, which boils down to this:

Are you toast? Or are you becoming toast?

Luckily for the folks at Canaan Partners, they have had some incremental good news from their portfolio, which suggests this venerable fund has as good a chance as any to be one of the survivors of the existential crisis in venture capital. Wende Hutton, a general partner with Canaan who’s been on board with the Menlo Park, CA firm since 1993, walked me through a laundry list of 14 encouraging news events from the first quarter, including three portfolio companies that are lined up to go public.

“We have had a lot of good news in our portfolio, particularly in the healthcare side,” Hutton says.

The timing couldn’t be better for a fund like Canaan to generate some good news. Venture capital has endured what some call a “lost decade” of lousy returns, which has put more pressure on VCs than ever to justify their existence to their big pension and endowment backers. Few VC firms dared to try to raise new funds in 2009 and 2010, when those pensions and endowments were feeling stung by losses in the stock market. Many VCs are expecting a mad dash on the fundraising circuit this year and in 2012, and those who don’t have a good story to tell are likely to wither and die. Estimates are that at least one-fourth or one-third of firms will simply fade away because they can’t raise more money.

Canaan has seen its share of cycles. It got started in 1987, and has raised a total of $3 billion through eight funds. The latest, a $650 million fund, was pulled together during a fortuitous moment in February 2008, before Bear Stearns, Fannie, Freddie, AIG etc. made the financial news pages into a horror movie.

When the stock market crashed and sent its shock waves through venture capital, Canaan was able “to take our foot off the gas,” Hutton says. That meant it treaded extra carefully in certain sectors that were hardest hit, and continue to reserve its capital for portfolio companies that really were hitting their milestones, Hutton says.

Wende Hutton

That might buy some time, but there’s no getting around the fact that some serious returns are going to have to materialize in the not-too-distant-future if funds like Canaan want to stay relevant in the future.

That’s why the latest news flow is so important—and perhaps why Hutton didn’t hide away from my meeting request. Three of Canaan’s portfolio companies—San Diego-based The Active Network, Westport, CT-based Advanced BioHealing, and Sunnyvale, CA-based Cortina Systems—have filed prospectuses with the Securities and Exchange Commission to go public. There’s no guarantee that any of these companies will generate liquid returns, but they all have a chance to do that in 2011. All three companies say they have generated more than $100 million in revenue in the past year, although only one (Advanced BioHealing) turned a profit in the most recent year, according to regulatory filings.

Besides the obvious potential for returns from those companies, the healthcare portfolio has shown some other encouraging signs. Five of Canaan’s life sciences companies secured non-dilutive financing during the first quarter, which essentially provides cash that helps make the companies more valuable without diluting the value of VC ownership stakes. Examples include Theraclone Sciences‘ potential $632 million partnership with Pfizer, a $10 million investment from the Bill & Melinda Gates Foundation in Liquidia Technologies, and a $118 million award for VaxInnate from BARDA, a biodefense research group within the U.S. Department of Health and Human Services.

“To us, this reflects that these companies are perceived as having high value programs,” Hutton says.

Canaan aims to put about one-third of its capital into healthcare, and it’s clear that healthcare has got its work cut out if it wants to compete with tech as a sector. New drugs and devices take a lot of capital, and a long time to pan out, if ever. That’s not exactly a recipe for success … Next Page »

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