Out of the blizzard of data I looked at this weekend, I thought I might pull out some interesting insights and trends which might be emerging. Feel free to challenge some of my conclusions.

• 4Q11 saw $6.6 billion invested in 844 which is up from $5.5 billion (861 companies) in 4Q10 although was down significantly from the $7.3 billion in 3Q11, which is odd given 4Q is usually greater given year end considerations and that 3Q includes July and August. Are we starting to see a tapering off?

• Seed investing in 4Q11 was a shocking 2% of overall activity (only $134 million in 80 companies – my bet is it is under-reported frankly) and well below the prior two quarters of 2011: 2Q11 was $412 million in 124 companies; 3Q11 was $223 million in 111 companies. Are the angels re-trenching? I have argued in the past that we may be seeing the “End of the Great Seed Experiment.”

• Interestingly seed and early stage investments in 4Q11 totaled $2.5 billion (or 36.5% of total dollars) in 444 companies (or 52.6% of all companies), confirming the rotation to seed and early stage investing and that those companies do not need that much capital.

• 238 software companies raised $1.8 billion ($7.4 million per company) in 4Q11 which was the single largest category. Second largest was biotech – $1.3 billion in 111 companies ($11.5 million per). Software captured 27% of all 4Q dollars invested, biotech was 19% of total. The smallest category? Business products attracted $24 million or 0.4% of total!

• There were 844 investments in 4Q11, the lowest level in any quarter last year. That has not happened in recent memory.

• $920 million dollars was invested in 4Q11 in first time companies which is 14% of all dollars invested. This compares unfavorably to 4Q10 of 16% and 3Q11 of 17.7%. Arguably being the first dollar invested in a company is the most risky round. Are VC’s cycling towards companies which have already raised capital?

• According to PwC only two states did not have one company last year which raised VC: Arkansas and Nebraska. Four states had only one company all year: Hawaii, Idaho, North and South Dakota.

• The largest “venture” deal in 4Q11 was the $250 million invested in Dropbox. The top ten largest deals attracted $1.2 billion in aggregate (or 18.6% of all dollars invested) for an average of $120 million per investment. Doesn’t really feel like venture capital to me.

• Lastly, the insufferable New York vs. Boston debate. In 4Q11 New England reported 107 deals versus 82 deals in New York, and 441 versus 379, respectively, for the entire year. New England captured $777 million dollars compared to $545 million in New York. Nearly 13% of all investments were in New England, almost 10% in New York metro area – which both look puny compared to the 273 investments in Silicon Valley (32% of total or $3 billion). Is Boston back? I don’t think it ever went away.

Interesting data. Mirroring the consolidation of venture funds, I think we are starting to see fewer entrepreneurs raising capital and there may be fewer “first timers” allowed in – particularly as the seed activity tapers off. Just a few thoughts.

So here is what the analysts don’t say. Let’s stay with the VentureWire data: of the $16.2 billion raised in 2011, $10.5 billion of that was raised by only 15 firms. That means 120 firms raised the remaining $5.7 billion for an average fund size of less than $50 million. That does not make sense to me. It certainly did not feel that robust to me and I am in the market every day.

But what does make sense to me is that the VC industry is both rapidly contracting and concentrating around a small fraction of the firms in the industry. The NVCA counts over 400 active members and presumes to represent more than 90% of the capital under management today. My guess is well below a 100 firms nationally can predictably raise a new fund in this environment.

Other NVCA data to ponder: in 2007, 237 funds raised $31.1 billion; in 2008 those numbers were 212 raised $25.9 billion; 2009 – 161 raised $16.4 billion; 2010 – 169 raised $13.8 billion – a five year low point which coincided with 10-year VC industry return numbers being negative. This year showed an upturn in overall dollars raised but it was driven by fewer, larger firms. Now that the 10-year industry returns data is once again positive, hopefully dollars will flow back into the VC industry.

What do you make of this? Is it good for entrepreneurs?

Suffice it to say the mood of the discussion was sobering and pointed to some very turbulent times ahead – for both the general economy and the VC industry specifically. In no particular order here are some of the key issues we covered.

• General consensus was that the “Gang of 12” or “Super Committee” meeting in Washington the past few weeks to hammer out budget and tax reforms will essentially fail. As is increasingly likely given the news over the last few days it appears there will not be a compromise and that the “forced cuts” will go into effect.
• A lot of hand wringing about the horrible state of VC fundraising. The most recent quarter results were a quarterly low point for the prior eight years (and yet the industry continues to invest at a $25-$30BN pace – that isn’t going to last and frankly probably ends badly). My personal guess is that the VC industry will struggle to raise $15BN this year – and much of that will be by less than a dozen or so firms.
• Considerable discussion around how the NVCA might help fix the broken IPO process. We developed the idea of an “on ramp” for companies below a certain size threshold, say $1BN in revenues, to transition to being fully compliant with regulations governing public companies. The NVCA will continue to push hard on this agenda item.
• Solyndra – agreed that we are probably past the half life of this story but unfortunately there are some in DC who will continue to flog this story for political gains. It appears that this is not a cleantech issue, not a DOE issue, but an Obama issue – and as such may not really go away until the FBI has completed its inquiry. Notably 42 companies were loan recipients and only 8 of them were VC-backed (and I am told most are actually doing quite well).
• Life science industry is in a world of hurt. The medical device sector raised capital in this past quarter at a level of 50% of the one of the lowest levels ever, that being in 2001. There has been a dramatic pullback in funding and rotation to anything that does not come within a country mile of the FDA – life science VC’s most favorite 4-letter word. Soon when bad things happen to you we will say “you were FDA’d…”
• Lastly we reviewed some fascinating data generated by an LP survey conducted this past summer. It showed that the private pension plans are still quite active investors. Notably of the $100BN raised by VC firms in 2000, only $46BN of that is managed by VC’s firms still in business. My industry is shrinking before our very eyes.

The day ended on a very cool note. Some of us had a chance to visit with senior members of the Federal Reserve. And while the specifics of the discussion are less relevant, I can report that there are very impressive conference rooms at the Fed. There were spectacular posters of every type of US scrip since the start of the country. And you thought entrepreneurs and VC’s have it tough during these times; you would not want to be the good people trying to navigate all these issues in DC.

The overall investment pace was quite impressive given that the quarter included a wild August in the stock market and the vacation slow down; investments totaled $6.95 billion in 876 deals. In 2Q11 there were 1,015 deals which raised $7.88 billion but in 3Q10 there were only 850 deals which raised $5.31 billion, well-below this past quarter. It feels like the VC industry is on pace to invest close to $28 billion this year, which continues to baffle me as VC’s will struggle to raise $15 billion in new funds. This will be the third consecutive year when the industry invested meaningfully more than it raised. That will probably end badly.

Couple of interesting observations I pulled out of the data with my calculator…

• Notwithstanding the buzz around seed investing, as a percent of total activity it was down notably this past quarter – only 3% of investments ($178 million) was seed versus 6% ($303 million) in 3Q10. There was $403 million invested in seed deals in 2Q11 more than twice this quarter.
• Average size of each seed round was $2 million – doesn’t really seem like seed investing to me! Average size of first rounds (“Early”) was $5.7 million.
• Life science investment activity is decreasing substantially – in large part to capital intensity and regulatory uncertainty. I would argue that as larger life science funds pull back or give up altogether, early stage investing will quickly follow suit. In 3Q11 life science investment was 28% of the total activity; this was 32% in 3Q10. Watch for this to get worse before it gets better.
• Since 2Q11 life science investing decreased 13% on a dollar invested basis. Cleantech also witnessed a meaningful decline.
• Software rocked this quarter – $2 billion was invested in 263 deals. Quite clearly investors are rotating out of sectors with long and uncertain development pathways to ones with revenue and nearer term liquidity options.
• An interesting VC risk barometer is the amount of “first time” financings and the news is not so good here. As a percent of all dollars invested, only 17% were “first time” ($1.2 billion) versus 20% in 2Q11 and 24% in 3Q10 – clearly a negative trend and most likely reflecting increasing risk aversion and many funds who fear not being able to raise new funds, just doing what looks safe. It is even more dramatic when focusing on “first time” seed investments which were 10% in 3Q11 down from 22% in 2Q11. My guess is we are beginning to see the end to the “Great Seed Experiment” – now that many companies seeded one to two years ago are hitting the wall – not every seed will raise a Series A.

I could happily drone on with more “fascinating” insights in the funding data but will pause there. Clearly VC’s are increasingly drawn to businesses which can drive near-term revenue (consumer internet/social media) and/or don’t have open-ended product development pathways (life sciences/cleantech). External forces like the hostile FDA or non-existent IPO markets are conspiring against certain VC-backed companies.

Ok, one more observation which I have been reluctant to even comment on – the ceaseless New York versus New England comparison. New York killed it this past quarter – $891 million invested in 103 deals, even better if you throw in metro Philly. New England’s results – $586 million and 108 deals – not so great. But hold on – year-to-date New England invested $2.36 billion in 324 deals as compare to New York’s $2.19 billion in 289 deals. While we very much respect the New York phenomenon – one of the Flybridge partners is there every week – hell, I am a Mets/Giants/Knicks/Islanders fan – this is a marathon, not a sprint. Anyway we think both markets can peacefully co-exist and in fact are near-perfect complements. They are only 180 miles apart.

                While there the September unemployment numbers were released:  the unemployment rate now stands at 8.1% – a full percentage point below the US rate. Amongst all the hand wringing was a sense that the UK economy was doing ok, thank you very much. There was evidence of reasonable consumer strength and while prices were ridiculously out of control – it seemed as if every five minute taxi ride was 15 pounds ($24) – there were no shortages of Bentleys, Porsches, Bugattis and Lamborghinis. It could also have just been that all the Russian Oligarchs and Middle Eastern Sheiks decided to go for a drive at the same time.

                One of our biggest issues in the US is the absolute freaking dearth of IPO’s – extremely frustrating and disheartening – so imagine my intrigue with the article titled “Newcomers Provide the Only Buzz for Overtired AIM (stock exchange)” in Thursday’s Financial Times. I expected yet another article lamenting the absence of public offerings in the UK just like in the US. Point of fact there have been 22 IPO’s in 3Q11 in the UK. Those companies raised 205 million pounds and covered a fascinating range of industries: the obligatory internet/ biotech/mobile marketing companies but also water purification, African agricultural and coal importing companies. Quite impressive I thought.  Interestingly though the AIM was not the most active stock exchange in Europe this past quarter – Warsaw saw 54 IPO’s on its stock exchange.

                One other set of observations – perhaps more troubling – was how many of the sophisticated financiers I met look at the current US situation. Notwithstanding the vast pools of capital across Europe all struggling to find investment returns greater than the 3-month LIBOR of 30 basis points available today, there was a collective apprehension to invest in the US innovation economy. That is simply baffling – we have a significant PR problem – if we cannot look more attractive than investment opportunities in Europe’s backyard (Greek bonds anyone?), that is a problem. The protracted infantile budget debate this summer hurt us more than we perhaps realize.

                The innovation economy is now comfortably a global phenomenon. We all know that but it is always entertaining to be reminded of that when traveling abroad. The problem is we should own it outright, and after a week in Europe, that just does not feel like the case right now.

I think I did a reasonable job defending Boston. While Carol was great, my biggest issue with the show was how it showed up on YouTube – “Greeley Says Boston VC Not Focused on Social Media” – which is nothing I ever said, quite the opposite actually. I stressed repeatedly that entrepreneurs in Boston solve really hard problems – I even used the word “intractable.” I referenced cloud computing, storage, infrastructure, robotics, life sciences as sectors we excelled at – although I did acknowledge that we might be guilty of selling out too early.

Boston has been #2 to the Valley for a long time in VC activity – admittedly even a distant #2 – both in terms of dollars invested and number of companies. We also are a smaller geography with crummy weather 6 months a year. In fact – and quite timely – late last week 2Q11 funding data was released and there are some interesting data there:

• Per CB Insights VC investment in Massachusetts in 2Q11 was $1.1 billion in 89 companies, up from $719 million and 85 companies the prior quarter, and up from $689 million and 85 companies in 2Q10
• Nationally $7.6 billion was invested in 768 companies (this continues to baffle me – VC’s are investing at a nearly $30 billion annual pace but we will only raise around $15 billion this year in new funds)
• 12% of all investment was deemed to be “seed” investing – a five quarter high
• Clear evidence of consolidation as California/Massachusetts/New York companies accounted for 74% of all dollars raised versus 69% in prior quarter (or 57% in 4Q10)
• Nationally 18% of dollars invested were “seed/Series A” versus 21% for “Series B”
• Internet was 36% of all dollars invested with healthcare (25%), mobile (7%), energy (6%), non-internet software (6%), and hardware (5%)  rounding out the balance

The diversity of industries represented in the Massachusetts data was impressive, and while some people wring their hands about us being #2,this diversity augurs well for a healthy VC marketplace in the future. Why do I say that?

• In terms of number of companies which raised capital in 2Q11, healthcare was 34% while internet (27%), non-internet software (13%), mobile (8%), energy (4%) and industrial (4%) were some of the other categories
• On a dollars invested basis, healthcare jumps to 52% of the total while internet (24%), non-internet software (5%), mobile (5%), energy (6%), and industrial (3%) fill out the balance

But what I often point to is the fact that of the $175 billion managed nationally by VC’s, the local VC community manages approximately $35 billion or 20% (more than the 15% our local companies attracted). We continue to have a strength of VC activity which is critical for the future health of the Boston innovation scene.

But we can not stop aspiring to launch the next Facebook here. Let’s not let the next great one get away – unfortunately it may just not be in social media/commerce.

 Building #9 houses the training modules for the space shuttles – about to be mothballed – and the space stations. These full scale models are used for training and to wildly impress VC’s. Watching the next crew of astronauts train was very cool. In addition to meeting a number of extraordinarily talented and committed Americans working on programs one might only expect to see on “24” or in sci-fi thrillers, I screened a number of projects to gauge commercial applicability. But just as important I picked up a number of cool facts such as:

•  A space suit costs $2 million and is made of 16 layers of materials
• Living quarters in the space shuttle are really really tight
• Typical space walk takes 6 to 7 hours
• Each astronaut sleeps for precisely 8.5 hours per 24 hour cycle in space “snuggies”
• It takes 4 hours to return to earth but a day and a half to get to the space station
• Upon re-entry the shuttle heats to 15,000 degrees (which is why they can explode with even the slightest damage to the heat shields)
• The typical trainer looks 18 years old
• Building #9 houses one of the largest air hockey boards for astronauts to practice weightlessness on
• It is very painful for the astronauts to walk when they return from a 6 month mission because the calluses on their feet have sloughed off
• You would never want to use a space toilet – and not just because your business is conducted in front of your crew
• Average noise on the space station is 65 db – and can get as loud as 90 db
• The space station goes around the earth once every 90 minutes
• The Chinese are offensively exploding other countries’ satellites creating an enormous issue with “space debris”
• The power of one rocket on the space shuttle is equivalent to 28 Hoover Dams

 I could go on with other interesting facts but I will share with you perhaps the most fascinating anecdote from the entire visit – and it had nothing to do with outer space.

 As a visitor I sensed that NASA is struggling with redefining its mission, its reason to exist – how best to justify the annual budget to support this type of research – particularly given how tough things are back here on earth.

 Toward the end of the visit we were treated to a presentation by the Deputy Chief Medical Officer for Johnson Space Center and his re-telling of NASA’s role in rescuing the trapped Chilean miners. Arguably the application of many of NASA’s discoveries and insights from space – when translated to this disaster – proved to be pivotal in rescuing all of the men. Some highlights:

•  While trapped 2,200 feet below solid rock, the miners were only at sea level given they were drilling in the mountains; and there were numerous tunnels and ample space to move around
• The earthquake loosened 600 tons of rock which effectively buried the miners
• There were enough rations to provide 100 calories per day per miner – much like the “re-feeding syndrome” NASA developed if there were ever a disaster in the space station (one needs to be very careful how one balances the various minerals in the body)
• The miners’ diets had to be modified to alter the carbon dioxide produced, oxygen consumed thereby altering the metabolic functions in the body – effectively the miners’ bodies had to be “re-tuned” to adjust to these harsh conditions
• It was 90 degrees in the mine and given that the miners were sleeping on hot rocks, they were experiencing significant muscle beak-down
• They had to be selectively hydrated based on their unique physiology to avoid renal failure
• The Chilean government deliberately had three drilling teams compete to drive innovation and speed
• The apparently simple extraction of the miners in the tubes was one of the most challenging maneuvers given the number of psychological issues, need for compression garments, fluid loading given the change in ambient pressures, etc

 As a kid I remember being fascinated with traveling on airplanes – now, not so much. Many of us grew up enthralled with outer space and on some level it is sad to see the budgets of NASA under siege. While I have not concluded for myself if that is a good or bad thing, there are a number of Chilean miners who are thrilled with the fact that we put men on the moon.

• In 2010 S&P 500 returned 15.1% and bonds returned 12.4%…cash returned 0.1%…apparently the worst cash return since 1940
• From 1900 to 2010 – yes, for 111 years – equities enjoyed an annual compound rate of return of 9.4% as compared to 5.6% for long-term, high quality corporate bonds
• For the past 111 years annual inflation was 3.1%
• If you invested $100 in 1900 in equities you now have $2,232,544
• And if you invested that same $100 in bonds in 1900, 111 years later you would have $40,400
• But if you put it in money markets – not sure what that was in 1900 – you would have $8,142

I certainly do not hope nor expect that our venture funds at Flybridge will take 111 years to mature but I have now a new-found respect for the power of compounding equity returns – and backing innovation.

Coincidentally the National Venture Capital Association (NVCA) and Cambridge Associates yesterday released VC returns data for 4Q10 which both made for interesting reading and suggests better days are ahead for VC investors – as evidenced by what happened today to LinkedIn. And this is not a post debating whether we are in a bubble…

Except for 15-year returns, performance was better across all time periods in 4Q10 than they had been in 3Q10. As I read the report I was most focused on 1/10/20 year returns data – some of the highlights of what jumped off the page are:

• 4Q10 vs. 3Q10 1-quarter performance was 8.4% versus 3.7%, respectively

• 4Q10 vs 3Q10 1-year returns improved to 13.5% from 8.2% – although the Dow and NASDAQ were up 14.1% and 16.9%, respectively, for the calendar year

• Unfortunately the 10-year performance also lagged the public markets – (2.0)% for VC compared to 3.2% and 0.7% for the Dow and NASDAQ, respectively

• But the 10-year number in 4Q10 of (2.0)% was much better than the (4.6)% 10-year number in 3Q10 – so trending in right direction

• VC performance really shines over 20-year timeframes: 26.3% versus 10.3% for both Dow and NASDAQ

It is quite evident that recent VC follow-on investment activity is driving a very rapid recovery in returns. The enormous mark-up’s we are seeing in the most notable, talked about companies – like LinkedIn – are starting to show up in many other on financings in the market and are now influencing investment performance data. With a number of other high-quality VC-backed companies now poised to go public one would expect to see this improvement only continue.

Not all the news is great though. Later in the report is an analysis of Distribution to Paid-in Capital (DPI) which measures how much LP’s are getting back versus investing into funds; this is a metric many LP’s focus very closely on. The VC model is built on LP’s being able to re-invest gains from early portfolio company investments to fund future commitments – thereby LP’s never actually have to come up with their entire commitment as it becomes in a sense “self funding.” A ratio greater than 1.0 means distributions are paying for the commitment…and we haven’t seen this ratio greater than 1.0 since 1998.

What does that mean? In essence the VC industry has been a net consumer of capital for a decade. And the order of magnitude of the DPI ratio is quite troubling. For funds raised in 2006, DPI is 0.09 – less than ten cents on the dollar. From 2007 to 2009 the DPI is 0.06, 0.05 and 0.01, respectively. Ouch.

Now it is not quite that bleak as LP’s also look at DPI plus Residual Value to Paid-in Capital. This ratio attempts to capture the fact that while not distributed, VC portfolios are still presumably building value – just in private companies. Fortunately that ratio has been above 1.0 since 2000 when it was 0.95 (2010 was 0.99…so I rounded up). Over the past decade this ratio has bounced from 1.04 to 1.30 so at least VC’s were not destroying value – just consuming a lot of capital.

The issue – we all know – is lack of liquidity. Liquidity drives distributions which allow for new funds to be raised and invested, but it also drives valuations. Everyone in Silicon Valley and Route 128 just marked-up all their portfolio companies thanks to what happened on Wall Street today.

 Hope it is sustainable. That is an entirely different post.

Much of the day was spent at the TechHub in East London where I met a number of local start-up’s and angel investors. TechHub is sponsored by Pearson, Google and Telefonica (much like CriticalMass in Cambridge, MA – not UK) and is considered the first true collaboration work space in London open just to entrepreneurs. While it was hard not to be constantly comparing this community with what I had seen in Tel Aviv and Jerusalem last week, I will offer up a couple of observations:

• East London is akin to Palo Alto or Kendall Square while Mayfair is comparable to Sand Hill Road or Waltham (or 500 Boylston Street in the Back Bay, where Flybridge is located!)
• The East London neighborhood – affectionately called “Silicon Roundabout” – is the tech cluster where it is estimated that there are 100 start-up’s
• Incubator space is a very big deal in London given the cost of property which is why there aren’t any/many
• Mike Butcher who runs TechCrunch in Europe described London for me as the “saloon bar” of Europe where people come in off the prairies of Germany/France/Sweden, etc
• Years ago the government initiated the Tech City Investment Organization which today is felt to have had a hand in the creation of 150 companies which raised 250 million pounds – impressive
• The local VC scene was characterized as “emerging” – only 400 million pounds was invested last year; some of the angels thought there were only 20-30 new “Series A” companies formed in 2010 by VC’s – I made a note to check that as it sounded like a really small number
• Less than 10 millionaires were created by Skype – further underscoring the lack of emphasis on equity compensation in the market

“Where is everybody?” was a common lament heard throughout the session. In addition to the lack of true entrepreneurial density in the market, the entrepreneurs were concerned by the ethos and cultural issues conspiring against them. One impression I had was that the English VC’s took a more measured, tempered approach to the business of early stage investing – can not point to any data but rather just the sense I left with. Not necessarily bad, but certainly different than what I witnessed last week in Israel.

Additionally I spent some time at the London Stock Exchange (looks eerily like the NASDAQ in NYC) as well as Lloyd’s of London where I met the CEO and toured the trading floor (which reminded me of the bond desks at Solomon Brothers in the 1980’s – again in NYC). The CEO claimed that Lloyd’s insured the tea thrown into the Boston Harbor a few hundred years ago!

At Lloyd’s I asked about the insurance industry’s exposure to the catastrophe off the coast of Japan. The Japanese tend to be more self-insured and government insured so the commercial exposure he likened to a Category 4 hurricane hitting the Florida coast – but under his breath he mumbled the economic losses will well exceed $100 billion dollars. Staggering. And this on the heels of the disasters in Australia, New Zealand, Chile in recent months…

So concludes the trip.