Fourth Quarter Venture Results—Shrinkage Comes in All Forms


Xconomy Boston — 

The Q4 2010 VC funding data were released late last week—and the headline was quite upbeat. VCs invested $5 billion in 765 deals in this past quarter, which while essentially flat quarter-over-quarter, brought the full year totals to $21.8 billion invested in 3,277 companies. In 2009, VCs put $18.3 billion into 2,927 companies. It’s easy to conclude that with volume up, the VC industry is on the road to recovery, but a new issue is emerging—the dreaded shrinkage.

The headlines turn out to mask some fascinating insights when one looks closer at the detailed data released in the MoneyTree Report prepared by PricewaterhouseCoopers and the National Venture Capital Association (NVCA), based on data from Thomson Reuters. Just a couple of tidbits…

Sector Rotation: Software is back—by a lot. In Q410, software as a category attracted $1.23 billion across 218 deals, far above the $853 million put into 72 deals for “industrial/energy” (which is effectively the cleantech category), which took the #2 spot. More notably, biotech—which had been #1 or #2 quite consistently over many quarters—dropped to #3, with only $685 million invested in 94 deals. Medical devices fell even further ($400 million and 71 deals). For the entire year software saw a jump of 20% in dollars invested over 2009.

Healthcare Investing: With biotech and medical device investments falling, the question that jumps off the page is, “Are we seeing the impact of the uncertainty of healthcare reform on the healthcare sector?” I think so. VCs do not like regulatory uncertainty, especially when coupled to extraordinary biological uncertainty. This downward investing trend is very disturbing, and without sounding too dramatic, if it continues, it will affect the quality of people’s lives.

Is Cleantech Back?: While the sector more than doubled from Q3 to Q4 this past year ($418 million to $853 million), I think it is premature to declare victory here. Clearly VC sentiment has rotated away from large supply side investments (generation and distribution look more like biotech’s risk profile). However, cleantech plays were strong in demand side management (usage monitoring, efficiency, which look more like software/hardware risk profile). Notably, the average dollar invested in cleantech in Q4 was nearly $12 million per deal, which is almost twice the $6.6 million for all deals in that quarter. Still, the field feels very capital intensive for VCs, whose own industry is shrinking. Which is my next point…

Shrinkage: This is something I have been tracking closely for the last few quarters. For the quarter, VCs invested $5 billion against what I would guess will be less than $3 billion raised in new funds when the reports come in. For the year, the numbers look like $21.8 billion invested, as compared to probably around $12 billion raised (this number won’t be reported for some time still). Arguably, the VC industry shrunk by $10 billion in 2010. That’s maybe not big a deal when you consider that in the U.S. the VC industry manages more than $200 billion—but much of that was raised and invested a decade or so ago. When—and how—this trend will be reversed is on everyone’s mind.

Stage Rotation: The shrinkage is evident in the allocation by stage of deal—more dollars are going into earlier stage companies, and these rounds tend to be much smaller in size. Seed and Early Stage deals captured nearly 30 percent of all dollars invested in Q4 (which was nearly identical to 3Q data). I also happen to believe that the level of Seed and Early Stage investing is wildly under-reported. This is not the case in the Late stage category, which dropped from 35 percent in Q3 to almost 24 percent in Q4; that difference showed up in Expansion stage (Series B), which went from 33 percent to 43 percent quarter-over-quarter. This makes sense, as we saw the advent of Super Angel and MicroVC models 12+ months ago—and many of the companies founded by those investors were out raising follow-on Series B rounds this past quarter. And with smaller new funds being raised in this environment, VCs are looking to invest less money per deal, which tends to push them to earlier (and smaller) round sizes. Notably, there were nearly 30 percent more new companies raising VC dollars in 2010 than 2009.

Boston Vs. New York: I was reluctant to wade into this debate, but here I go. New York had a very strong fourth quarter, but not strong enough to eclipse Boston (by metro region) for the year. In 2010, there were 313 deals that raised $2.12 billion in Boston as compared to 350 deals that raised $1.87 billion in New York. If you expand the Boston aperture to New England, the numbers are 387 and $2.54 billion, respectively. In terms of deals and dollars, Boston and New York were basically the same in Q4, though, so quite clearly New York is catching up to Boston as a region, which very directly reflects the explosion of digital media and Super Angel activity in NYC. Average deal size in NYC is much smaller than that for Boston.

    All in all, a reasonably good quarter. What the data do not comment on are liquidity events—which is the real elephant in the room. Until we can show predictable, repeatable liquidity, the VC industry will shrink. That hurts anyone playing in the Innovation Economy.

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