Doh! Venture Capital Investment Dips 7% in Q3

Posted by: Spencer Ante on October 20, 2008

Venture Capitalists are taking their foot off the gas pedal ever so slightly. In the third quarter of 2008, VCs poured $7.37 billion in venture capital into 583 deals, 7.2% less than the $7.94 billion put into 673 deals during the same period last year, according to a Dow Jones VentureSource study released Oct. 18.

This marks the second consecutive quarter of year-over-year declines, and the rate of decline is increasing. In the second quarter, venture investments dipped 5.7%, compared to the year-ago quarter.

These numbers jive with the Oct. 17 survey released by the MoneyTree Report from PricewaterhouseCoopers and the National Venture Capital Association, which also reported a 7% drop in overall VC financing.

Similarly, the report confirmed the growing sense that VCs are allocating more of their dollars to later-stage companies, which tend to be less risky than early-stage companies. Second and later-stage rounds dominated investment with $5.89 billion, or 82% of the quarter’s investment total, versus the third quarter of 2007 when second and later-stage rounds accounted for 77% of capital investment.

“Venture funds are more hesitant about backing companies they are not 100% confident in,” says Adeo Ressi, founder of TheFunded.com, a Web site that lets entrepreneurs rate venture capitalists. “But they are putting more money into companies that they feel are winners.”

The lone bright spot was green technology. For the first time, renewable energy investment busted through the $1 billion mark. Specifically, the data showed that investments in the energy and utilities industry reached a record $1.18 billion in 32 deals during the third quarter of 2008, up 90% over the $620 million invested in 35 deals during the same quarter last year.

“Energy efficiency is a long-term sustainable global opportunity,” says Paul Holland, general partner with Foundation Capital, a venture firm that stepped up its commitment to green technologies by recently raising $250 million to invest in the area. “We need to more than double our energy capacity in the next 25 years.” Foundation first started investing in green tech in 2003.

Like third quarter earnings reports of public companies, most analysts believe that the VC numbers don’t fully capture the impact of the financial meltdown. For that we’ll have to wait and see the fourth quarter numbers.

But my hunch is that this downturn–while clearly worse for the overall economy–won’t be as painful for startup land as the last tech bust. Sure, many startups will go go under (and some already have), but the wipeout won’t be as big as the last dot com bust.

Why? For starters, fewer new companies have been formed during this recovery. Second, VCs have been much more limited and rational in their investments, so there is not as much of an investment overhang. And third, the companies that have been formed over the last five years are running their businesses far more efficiently. So more startups can get by with less money.

The bad memories of the last bust have not faded completely. That means VCS and entrepreneurs haven’t done as many silly or stupid things, like spending millions of dollars on parties or Super Bowl ads.

Here’s the full release:

SAN FRANCISCO and NEW YORK, Oct 18, 2008 /PRNewswire via COMTEX/ —-Dow Jones VentureSource Finds VC Focus Shifts to Existing Portfolio Companies; Renewable Energy Attracts Record $1B; SF Bay Area See Most Investment Since 2001

SAN FRANCISCO and NEW YORK, Oct. 18 /PRNewswire/ — As the economy weakened during the third quarter, venture capitalists continued to rein in investments in U.S.-based companies, according to the Quarterly U.S. Venture Capital Report from Dow Jones VentureSource (www.venturecapital.dowjones.com). The third quarter of 2008 saw $7.37 billion in venture capital invested into 583 deals, 7% less than the $7.94 billion put into 673 deals during the same period last year and the second consecutive quarter of year-over-year declines.

“Clearly, the current economic crisis is already impacting the venture industry, which has traditionally been relatively insulated from fluctuations in the broader economy,” said Jessica Canning, Director of Global Research for Dow Jones VentureSource. “With the IPO market likely to be shut down for some time, venture capitalists are pulling back on investments in technology companies as well as in areas like business and financial services and media, content and information that are likely to suffer from a decline in advertising and enterprise spending. At the same time, VCs are allocating more resources to energy deals, which stand to benefit from a shift in federal and state energy policies.”

Renewable Energy Investment Breaks $1B Mark for First Time

Most notably, the data showed that investments in the energy and utilities industry reached a record $1.18 billion in 32 deals during the third quarter of 2008, up 90% over the $620 million invested in 35 deals during the same quarter last year. Specifically, 18 deals in the renewable energy category accounted for a record $1.08 billion in investment with the majority of that capital going to solar companies.

“While there are a relatively small number of deals being done for solar power and other renewable energy companies compared to traditional VC areas like software and IT, they’re attracting huge amounts of capital and that’s to be expected,” said Ms. Canning.

One of the top venture deals in the third quarter belonged to a solar company, SolarReserve of Santa Monica, Calif., which raised $140 million in its second round.

IT, Web Companies Suffer; Health Care Flat

The data shows that the information technology (IT: 18.15, -0.40, -2.15%) industry saw deal flow fall to its lowest point in more than a decade, dropping 21% from 342 deals in the third quarter last year to 270 in the most recent quarter. Likewise, IT investments dropped 21% from $3.44 billion to $2.73 billion year-over-year. Software accounted for the bulk of investment with $1.15 billion invested in 125 deals, down 13% from the $1.32 billion put to work in 149 similar deals during the same period last year.

For the first time in nearly three years, the information services sector saw a decline in interest from venture capitalists with $501 million put into 64 deals, 11% less than the $561 put into 83 similar deals during the third quarter of 2007. Information services include many of today’s “Web 2.0″ companies, most of which rely on advertising as a source of revenue.

The Web-heavy consumer services industry also saw investment pull back, declining 47% from $286 million to $151 million in the most recent quarter while deal count fell from 32 to 20. The travel and leisure sector (down 79% to $28 million) accounted for most of the decline.

After two consecutive down quarters, the health care industry rebounded to post a virtually flat quarter with investment down 2% to $2.16 billion in 152 deals during the third quarter of this year. The biopharmaceuticals sector saw investment tick up 4% from $1.13 billion in the third quarter of 2007 to $1.17 billion with the deal count remaining relatively unchanged at 70. Medical device companies posted their third-consecutive down quarter as investment fell 17% from $876 million to $727 million in the most recent quarter while the deal count held steady at 55.

According to the report, the business and financial services industry saw investment drop 26% from some $1 billion in the third quarter of 2007 to $740 million in the most recent quart as the financial institutions and services sector took a hit in the face of the economic crisis.

The consumer goods industry posted its best quarter on record with investment skyrocket to $223 million — up 233% from $67 million — on the back of larger cleantech-related deals in the vehicles and parts sector.

Focus Shifts to Older, Later-Stage Companies

The quarterly report also confirmed that many venture capitalists are choosing to focus on established portfolio companies as second and later-stage rounds dominated investment with $5.89 billion, or 82% of the quarter’s investment total, put to work in 368 rounds — versus the third quarter of 2007 when second and later-stage rounds accounted for 77% of capital investment.

Specifically, second rounds saw the largest gain with 150 deals and $1.88 billion, the highest investment total for these kinds of deals in two years. Conversely, investments in seed and first rounds dipped to $1.30 billion invested in 203 rounds, a two-year low in terms of investment.

The overall median size of a venture capital deal in the U.S. —including all stages of development — held steady with 2007 at $7.5 million, still the highest total on record.

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Bloomberg Businessweek writers Peter Burrows, Cliff Edwards, Olga Kharif, Aaron Ricadela, and Douglas MacMillan, dig behind the headlines to analyze what’s really happening throughout the world of technology. Tech Beat covers everything from tech bellwethers like Apple, Google, and Intel and emerging new leaders such as Facebook to new technologies, trends, and controversies.

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