US venture capital
investment drops

28 Apr 2005

First-quarter venture capital (VC) funding in the US fell to US$4.6bn from US$5.4bn in the previous quarter, a MoneyTree Survey by PricewaterhouseCoopers, Thomson Venture Economics (TVE) and the National Venture Capital Association (NVCA) reveals.

“VC investment was down this quarter, but it still fell within the US$4-6bn range that we consider to be at a rational, investable, performance-driven equilibrium,” said Mark Heesen, president of the NVCA.

“We would like to see the industry stay within this ‘ripe zone’ for the remainder of the year, as a US$20-$23bn annual investment level is a logical place to be considering market conditions. We are also looking for a noticeable up tick in the percentage of earlier stage deals which has yet to occur, but we anticipate taking place as venture capitalists begin to deploy recently raised new funds.”

First-time financings have been trending slightly upward over the past two years. The increase to US$1.2bn in the first quarter compared to an average of US$1.1bn last year is notable in that it accounts for 26pc of all VC funding compared to 21pc last year. This was the highest proportion since 2000.

The strength in Q1 2005 was attributable to a diverse mix of companies receiving VC for the first time. Companies in the early stage of their development typically account for the bulk of first-time investing. While that remained true in Q1 2005, several companies in the expansion stage of development secured significant initial VC.

And these companies generally require larger investments. In the first quarter, 123 early-stage companies attracted an average of US$4.5m per company for their first round of funding, while 36 expansion-stage companies got an average of US$11.4m and nine later-stage companies an average of US$20.1m each.

Further, first-time investing encompassed a wide range of industry categories including financial services, industrial and healthcare services alongside the expected technology and life sciences companies.

After two years of dominance, the life sciences sector (biotechnology and medical devices industries, together) fell significantly in Q1 2005 to US$1.08bn, compared to US$1.6bn in Q4 2004 and the lowest amount since Q1 2003. A total of 129 life sciences companies were funded versus 162 in the prior quarter. The sector accounted for 19pc of all deals and 23pc of all dollars during the period — still a solid level, reflective of recent market conditions.

The software industry remained the largest single industry category with 198 companies capturing US$1.1bn. Though both figures were down slightly from the prior quarter, software represented 24pc of all VC dollars and 29pc of all deals, in line with historical norms.

Telecommunications investing continued to slide with 58 companies garnering US$371m, well below its average over the past two years. The networking industry turned up slightly to US$348m in 40 companies, but still languished below its two-year average.

IT services bounced to two-year high of US$302m on the strength of a single large deal.

Funding by stage of development saw later stage decrease slightly in Q1 2005 to US$1.8bn. This amount still represented 40pc of all VC, the same proportion as last quarter and a 10-year high. However, the average post-funding fell to Us$60.6m for the 12 months ending Q4 2004 compared to US$70.2m for the Q3 2004 period.

Of particular note, the 16pc of all VC investing going to early-stage companies in Q1 2005 fell only slightly from the 18pc in the prior quarter.

Investing in expansion stage companies dropped slightly versus the prior quarter to US$2bn in Q1 2005. This represented 43pc of all VC, slightly below the average over the past year. Average post-funding valuations increased slightly to US$58.6m versus US$55.9m for the prior period.

Adam Reinebach, vice-president at TVE, said: “Stage preferences have been fairly stable over the past year or so. Many of the companies being funded today got their first rounds during the boom years and made it through the dry period of 2002-2003. Given the VC market’s emphasis on management experience, as well as exit conditions, it’s not surprising to see the continued trend toward late and expansion stage deals.”

By John Kennedy