Do Stealth Deals Cause Drop in Q1 Deals?

Venture capital disbursement volume fell in Q1, and certain investors once again are blaming the decline on an increase in “stealth” funding rounds. Like before, however, such assertions are disputed by the data.

A total of 674 U.S.-based companies raised about $4.63 billion in the first quarter of 2005, according to the MoneyTree Survey figures released today by PricewaterhouseCoopers, the National Venture Capital Association and Thomson Venture Economics (publisher of PE Week). That represents about a 14% drop in deal volume and a nearly 15% decrease in disbursement volume from the $5.44 billion raised by 776 companies in the preceding quarter. Compared to the similar three-month period in 2004, deal volume was a bit higher (674 vs. 665), while disbursement volume was significantly lower ($4.63 billion vs. $5.03 billion).

So why has there been a disbursement decrease when so many entrepreneurs seem beset by term sheets?

One explanation could be that investors are spending additional time on international deals that don’t get tracked by the MoneyTree Survey. A more popular scapegoat, however, has been that today’s VCs are partial to keeping startup companies under wraps until patents are received (at the earliest) or a product is ready for commercialization (at the latest). In other words, all press is no longer believed to be good press, particularly when potential competitors might be reading the papers.

Mike Moritz of Sequoia Capital touted this strategy at a recent conference, and its wisdom has been debated at various VC-centric blogs over the past several weeks. What has gone almost unquestioned, however, is the follow-on argument that, whether stealth deals are good or bad, they are happening more frequently, and are helping to drive down quarterly MoneyTree data.

The last time we heard this was in Q3 2004, when disbursement volume fell more than 23 percent. At the time, PE Week pointed out that MoneyTree receives a number of surveys that include “confidential” deal information, which only is included for calculating quarterly totals (i.e., no company or investor names are disclosed).

Also, confidential deals tend to be for seed-stage or early stage deals, and even a massive influx of such deals wouldn’t have done much to move the overall disbursement needle.

Which brings us to Q1 2005, where stealth deals are apparently again to blame.

The Deal Flow blog at BusinessWeek’s website, for example, predicted an overall disbursement increase, depending “on whether the researchers count all of the deals that were done.” It then goes on to list six so-called stealth deals. Not only are half of them listed in the MoneyTree data by name (BA Systems, FilmLoop and Spatial Photonics), but it’s also possible that some of the others are among the “confidential” submissions. Overall, MoneyTree reports 16 such deals in Q1 2005, totaling $133.2 million (the investment total is skewed higher by two transactions of $40 million and $45 million; see chart below). This represents an 11% decrease from the 18 confidential submissions in Q4, which is fairly close to the 14.3% drop in quarter-to-quarter deal volume.

Inside the Numbers

The quarter’s largest deal was for Webroot Software Inc., a Boulder, Colo.-based provider of anti-spyware solutions, which raised $108.75 million in a Series A funding from Accel Partners, Mayfield and Technology Crossover Ventures.

FibroGen Inc., a South San Francisco-based drug company focused on stopping pathological scarring, was next with a $107.25 million Series F round, while the top five was rounded out by Perlegen Sciences Inc. ($74 million), Datran Media Corp. ($60 million) and an undisclosed company ($45 million).

Per usual, most VC-backed companies were in the IT sector (65.78%), while Northern California was the most popular home base (36.64%).