NVCA Today

Against a backdrop of lower levels of investment, an anemic exit market and growing optimism for public market stability and growth, the statistics confirm that the US venture capital industry remains very much open for business. First time financings are being done for the most promising opportunities. Later rounds continue, although on a smaller scale than two years ago. Fundraising remains challenging.. IPOs remain scarce, although there is some pickup in registrations, and the M&A exit market remains weak.

MoneyTree Investment in Companies

Venture capital investment levels have shifted lower. After several years of investment in the upper-$20 billion levels, full year 2009 investment did not reach $18 billion. All indications are that the industry is operating in a new size band.

The conflict for venture capitalists’ attention (and dollars) between existing later stage portfolio companies and newly-arriving business plans continues. While the actual number of later stage deals declined in 2009, the proportion is still historically high. While many of the later stage companies did not receive further funding in 2009, the number of these companies in portfolios is still at record levels. With IPOs occurring at a mere trickle and M&A markets slow, there is no place for these companies to go.

While reports from the field are that VCs are seeing high quality deal flow from good teams, the industry has nonetheless reduced the number of new portfolio companies it is taking on. After years of taking on 1,000+ companies each year, the industry in 2009 funded 725 first time companies.

Fundraising and Commitments

Fundraising, which for all but the most proven and promising firms had been difficult over the past several years, slowed dramatically in 2008 and was even slower in 2009. A significant portion of the capital raised in 2009 was by large, established firms. Many factors contributed to the slow pace including over-allocation to the asset class by some LPs (the “denominator” effect), poor recent distributions interrupting the recycling of capital effect, and investor selected focus on only the most promising fund managers.

In 2009, fundraising slowed dramatically with only $15.2 billion raised – half the level of recent years. This is the lowest amount raised since 2003.

While the industry has had capital on hand, an ever-increasing portion of that is earmarked for follow-on investment in existing portfolio companies. A prolonged fundraising drought could make future investment difficult.

IPO Draught Continues As Later Stage Companies Consider 2010 Strategies

It’s not surprising that the attention to slow exits for later stage companies has been focused on the poor public equity market appetite for new offerings. IPOs are generally the most successful form of exit for the venture firms and the investors. Cash raised through the IPO process is distributed to the LP investors which in turn the LPs generally recycle into future venture fund commitments. This ecosystem has stopped working.  In 2008, there was a dismal total of 6 venture-backed IPOs. There were no IPOs in Q1 2009 and only a dozen in the remainder of the year. The zero IPO quarters in Q2 2008, Q4 2008, and Q1 2009 represent the first, second, and third occurrences since the 1970s.

To put the recent IPO drought into perspective, assuming 14% of venture-backed companies go public (which was the case with companies first funded in the 1990s) and 1,100+ come into the system (first time fundings) each year, we would expect 150+ IPOs each year. While it is likely that the world going forward will be different than the 1990s, we know that 6 IPOs or 8 IPOs per year will not sustain the industry.

At the end of 2009 there were 29 companies in registration to go public. As of early February, this number had increased slightly but there is no significant uptick in IPO activity at this point.

M&A Activity Also Slows – Strong Acquisition Valuations Become Scarce

Unfortunately, acquisition exits are not faring much better. There were only 262

acquisitions in 2009, which is far below the 350 or so annual run rate for much of the post-bubble period. Based on those deals with disclosed prices, those acquisitions that did take place were small. Approximately $12.3 billion was raised through M&A – a small fraction of traditional levels.

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* - MoneyTreeTM reports start in 1995 although data is available going back to 1980 and earlier

** - In the fundraising chart, the number of funds raising money during the year will be less than the sum of the funds raising money in each quarter. This is because a fund can, and typically does, raise money across multiple quarters.