What Is Going On Out There?

The third quarter venture funding stats were released today by National Venture Capital Association (I am on the NVCA Executive Committee so am a big fan of their data) – always makes for entertaining reading. It is a little bit like looking for clues, especially in this market to help explain what the hell is going on out there. ..

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.

9 Comments

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9 responses to “What Is Going On Out There?

  1. Thanks for the great post. I’m only a distant follower of the data anymore. But I continue to wonder why the NVCA doesn’t collect data on distributions from VC firms to LPs. It’s the easiest set of data to collect, and without it the investment numbers are only of partial value. If one of your partners came back from a portfolio company Board meeting and talked about how the company was doing on the basis of trends in expenses, and you asked, “What is going on with revenues?,” I doubt if you’d be too happy with the answer of “We’re too busy to track that.” But that’s what the venture industry does. And the data on investments in extrapolated from survey responses (which were around 10% when I was involved in this process), while you’d only need data from a dozen LPs to be able to estimate distributions accurately.

    • Great insights, Ted. I have seen that data but it is not broadly published. Unfortunately, as we all know, it is pretty aweful for the industry – improving but nonetheless not something we collectively should be proud about.

      Love tracking all your exploits around the world. Stop in when next in Boston!

  2. Nice summary and analysis…clearly Seed is a “risk-on vs a risk-off” proposition…these numbers track the overall financial market which is “risk-off” of late. “Visibility and Predictability” will dry up investing and that’s what we’ve got now. Forget Europe, soverign debt and global growth. The first two go hand-in-hand and will get worked out in time. We can’t stop the L-T Global growth underlying China, India, Brazil and their populations. The problem lies here in the U.S….Absence of Gov’t leadership, taxes, housing and a looming election suggests more stagnancy, a trading range bound financial market and business not willing to invest into uncertainty. None of this will change until the Street begins to discount the election.

  3. How can you be a Mets and Islanders fan and see profess to be able to “pick winners”?

  4. Michael – can you explain the difference between the $28b invested by VCs and the $15b raised by companies? Is this just a reporting discrepancy? It seems like a huge gap to me.

    • The $28BN is what I believe will be the amount invested in private companies by VC funds in 2011; the ~$15BN is how much will be raised by VC firms this year in new funds, which will be the capital that will be invested over the next 3-5 years.

  5. Michael.. great post with your usual welcome candor. Ted’s comment about VC returns not being disclosed is dead on. But the core problem contributing to the lack of returns is the exclusive focus on Equity Exits as the only way to liquidity for investor and entrepreneur alike! The math worked great in the 80’s and 90’s but just doesn’t work now! The <$50M IPO market is shut down due to a host of factors (Sarbanes, no bid-ask spreads, no small-co analysts, no trading desks) and that doesn't appear to be fixable. Worse, with the stunningly large and growing supply of tech companies available to buy combined with fewer companies to buy them due to years of consolidation, it's a buyer's market. Result: fewer deals at declining prices. The price of M&A deals is down to where the MEDIAN deal size in 2011-Q3 was about $18M, hardly enough to support a VC industry as currently structured. And the average length of time for those companies lucky enough to exit is now approaching 10 years, which means more capital injection and lower IRR. Yet I don't see any restructuring of the VC industry that reflects this new and different company marketplace — it's still equity financing dependent on exits ala 1985. Yeah, there are more VCs doing seed deals with small dollars, but clearly this isn't a business model that works well for a VC partnership model still structured on larger deals. VCs need to think of alternative models like Revenue Royalty financing and SecondMarket that better map to this new environment and provide better liquidity for investors and entrepreneurs alike.

    • As always I agree with (almost) everything you said! Clearly the traditional VC model is under great pressure but I believe my industry has a marvelous ability to re-invent itself. All of those structural issues you cite exist and will still take a few years to sort itself out. From 2009 to 2012/2013 I think the VC industry will be cut in half – fewer active firms, smaller funds, fewer general partners making investments.

      I would disagree that seed investing can not be done in the context of VC firms. As firms get smaller, deal size will get smaller. As VC’s fund to nearer term milestones, deal sizes will get smaller. And the investment returns data continues to support that early stage investing generates the best returns – admittedly loss ratios may also be higher – but across a portfolio of investmenst it is the new innovative technologies and business models which drive returns – and that is not lost on (most) VC’s. Approximately half of our deals this year started as seed investments.

      Let’s create a panel/event to debate the seed phenomenon – we can call it “It’s is 2015 – Looking Back, How Successful was the Super Angel phenomenon” – a lot of fireworks…

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