VC Funding Remains Tight

The market for venture money appears to have bottomed out, but VCs remain cautious.

Venture capital funding for tech companies is bouncing back modestly from what appears to have been a low point late last year.

While VCs are circling companies in such hot growth areas as mobile communications, Software as a Service (SaaS) and green technology, they're also taking a more disciplined approach to investing than in years past.

VCs invested a paltry $17.7 billion last year, the lowest level since 1997, representing a sharp 37 percent decline from the $28 billion invested in 2008 and the $30 billion in 2007. The figures were released in March by PricewaterhouseCoopers LLP, which published its 15th annual MoneyTree Report.

The report, based on data compiled by Thomson Reuters, showed that funding started to plummet in the fourth quarter of 2008, when the overall economy went into a freefall on the heels of the collapse of Lehman Brothers Holdings Inc. and AIG Inc. In concert with last summer's recovery, VC funding picked up incrementally in the third quarter, though it dropped nominally in the fourth quarter at $5.1 billion and $5 billion, respectively.

In a presentation of the report at a New York Technology Council meeting March 18, PricewaterhouseCoopers Partner David Silverman said the market for VC funding and successful exit strategies remains depressed. "I wish I had better news," Silverman said. "The venture capital industry followed the overall economy and declined fairly significantly."

"Things are a bit rough out there," said Pimm Fox, anchor of Bloomberg Television's "Taking Stock," who moderated a panel discussion of five VCs and the CEO of a company that received funding from one of the firms.

VCs funded 2,795 rounds last year, compared with 3,985 in 2008. Median deal sizes were also down. The average round was $2.8 million last year, compared with $3.3 million in 2008 and $3.8 million in 2007.

Biotechnology firms got the most last year, $3.5 billion, down 19 percent. A total of 619 software companies received $3 billion in funding last year, down 40 percent. More than 200 IT services firms received a total of $1.1 billion, down 41 percent for the year. Among other areas: 118 semiconductor firms received $772 million, down 53 percent, and 140 telecom companies received $559 million, down 67 percent. The one area that seemed to see the lowest decline included companies that offer networking gear, where $716 million in funding represented a mere 5 percent drop covering 93 deals.

Year No. of M&A Deals Average M&A Deal Size (in millions)
2005 350 $106
2006 375 $116
2007 378 $176
2008 348 $115
2009 262 $144
Source: PricewaterhouseCoopers LLP/National Venture Capital Association MoneyTree Report

Table 1 Venture-Backed M&A Activity Dove, but Average Deal Sizes Rose in 2009

The study also found over the last year a shift from later-stage companies to earlier-stage companies, Silverman said. Investments in later-stage companies overall were nearly $6 billion with 799 deals, down 44 percent over the prior year. Companies receiving expansion funding dropped 47 percent with $5.4 billion allocated to 801 businesses. Early stage funding dropped only 13 percent covering 883 companies for a total of $4.6 billion, though it jumped 32 percent in the fourth quarter compared to the prior year and up 51 percent from the prior quarter.

"After the tech bubble, we saw a shift going into later-stage companies by VCs away from the early stage, and only recently have we begun to see a reversal of that trend," Silverman said. "That's good news for companies that are forming young, early stage companies -- VCs are beginning to look at them again. We see the same or similar trend for the full year."

Yet perhaps the worst news from the PricewaterhouseCoopers report was the state of exits. Though IPOs doubled last year over 2008, "it's still at a paltry 13 [percent]," Silverman said. "That's not a number that's going to be sustainable to bring us back to the levels of venture investment that we saw in prior years."

Those seeking funds are seeing higher scrutiny of their business models. "There's less willingness to let it ride now than there used to be," said Vytas Kisielius, CEO of Collections Marketing Center LLC. VCs are looking more closely at the customer sets of the companies they're considering investing in, Kisielius added. "It takes so much more proof that there's a real market and that there's real customers."

Kisielius, who described himself as a "serial entrepreneur," said it's important to be realistic when making your case to potential investors these days.

"I've never been one to believe that the investors are here for my benefit, but for our benefit. If I make it good for them they'll make it good for me," Kisielius said. "If I can't make it good enough for both of us, I know who's going to win: It's not me. That's the way the deal works."

About the Author

Jeffrey Schwartz is editor of Redmond magazine and also covers cloud computing for Virtualization Review's Cloud Report. In addition, he writes the Channeling the Cloud column for Redmond Channel Partner. Follow him on Twitter @JeffreySchwartz.