Monday, November 10, 2008

(REPRINT) VCs quickly turn off tap


10 November, 2008

VCs quickly turn off tap

The number of deals slows dramatically in October

Whoa, Nelly! The Wall Street financial crisis has caused venture capitalists to pull back sharply on their investment reins.

In October, U.S.-based venture firms did fewer investments than in any other month in nearly five years, according to preliminary data gathered by Thomson Reuters (publisher of PE Week).

Official data for the month of October won’t be released until after the end of the fourth quarter, when Thomson Reuters has collected quarterly surveys from venture firms.

The preliminary numbers indicate that VCs are hunkering down more quickly than they did after the dot-com crash. The data show that U.S.-based venture firms invested in just 250 companies last month, down from 565 companies in September and 518 companies in October 2007. You have to go all the way back to January 2004 (when they invested in 232 companies) to find a lower number. The only other October with fewer deals was in 1993.

“I’d venture to guess that the Q4 slowdown is going to be acute,” says Venky Ganesan, a managing director at Globespan Capital Partners, an early stage tech investor based in Palo Alto, Calif. “You can’t have the destruction of 40% of investor capital, or $10 trillion, and not have an effect on the economy.”

The amount of capital that VCs are investing also plummeted in October, when U.S.-based firms put $2.5 billion to work, down from $3.8 billion in September and $3.2 billion in October 2007.

The October 2008 total is the smallest amount that U.S. VCs have invested since February 2006, when they invested about $2.4 billion. Looking only at October, the last time the monthly total was lower was in October 2004, when about $2.4 billion was invested.

Maybe more telling is how few firms are actually doing deals. Just 240 U.S.-based venture firms made investments in October. That’s the lowest number since November 1997, when 239 firms made investments.

The anemic numbers are similar to those of 2002, when VCs pulled back following the dot-com crash. For example, U.S. firms invested $1.6 billion in 278 startups in October 2002.

Two of three VCs contacted by PE Week said they would be surprised if the venture business had pulled back as quickly as the data indicate.

“I wouldn’t have expected [the Wall Street financial crisis] to have had such a quick effect [on the VC business],” says Sanjay Subhedar, a general partner at Storm Ventures, an early stage investor based in Menlo Park, Calif. “I expected things to contract significantly in terms of investments in Q4 and certainly in Q1 and Q2 of next year.”

It would be unusual for deal numbers to drop so quickly because it takes time for VCs to put deals together, Subhedar notes. If the numbers did drop that quickly, it would suggest that a number of deals that were supposed to get done in October were put on hold.

Similarly, Bart Schachter, a managing director at Blueprint Ventures, a San Francisco-based firm that focuses on IP spinouts, says he wouldn’t expect total deal volume to decline so quickly. Still, he says: “I wouldn’t be surprised if outside-led financings have completely dried up.”

In other words, if a startup is trying to raise a Series B round, it is very unlikely in the current market for a new investor to come in and lead the round, Schachter says. Instead, the previous investors are doing the round without any outside help.

“Everyone has their arms tightly wrapped around their existing portfolio,” he says.

For his part, Ganesan says the venture market has already slowed down. “Globespan will continue to look at a lot of stuff, but the bar has gone really high and there’s no urgency of doing investments,” he says. “If we end up doing any deals, it will be one or two in Q4.”

A recent survey of 33 Bay Area venture capitalists showed that their “confidence” had hit its lowest point since the survey began in the first quarter of 2004. The Silicon Valley Venture Capitalist Confidence Index fell to 2.89 points on a 5-point scale, marking its sixth consecutive quarterly decline.

Alexander Haislip contributed to this story.

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