Investors ignore dearth of exits, focus on making deals

Venture fund-raising and exits took a hit in the third quarter, but a closer look at the data reveals a healthy industry. A large portion of the funds raised in the quarter is going to China and India, meaning fewer venture dollars will be chasing too few deals domestically. On the exit front, the IPOs that have been able to get out the door are doing well, and even though no one is predicting a surge in public offerings, most expect M&A to heat up in the coming quarter.

Overall, VCs are feeling good. They put nearly $6.5 billion into more than 800 startups during the third quarter, up from $5.6 billion invested in more than 770 startups during the same period last year. The biggest jump in financing went to early stage companies, and that trend is expected to continue.

“We’re seeing a lot of first-time entrepreneurs and a fair number of people coming through who made a fair amount of money a while ago and have been working on something in stealth, funding it themselves,” says Granite Ventures Managing Director Len Rand. Those people are starting to feel there’s a chance for venture money because the bad taste has left the room.”

Other investors attest to the abundance of good early stage and seed opportunities. “We’re seeing more good deals than we can do diligence for,” says Laura Roden, managing director of The Angels Forum. Garage-type startups are once again attracting the attention of VCs. Roden says she saw a big VC firm cut a $250,000 check to an early stage startup recently out of desperation to get in on the deal. “It wouldn’t have been worth the time it took to sign their name before,” she says. The Angels Forum has even fielded calls from hedge funds looking to get in on the early stage action, she says.

“There’s a lot of activity going on,” says Formative Ventures General Partner Clint Chao. “We’re seeing a pretty busy slate of deal flow, coming from all directions.” He attributes at least some of the increased interest in entrepreneurship and deal flow to big liquidity events in the Internet sector. “You’re seeing some interesting exits from the M&A side of things which I wouldn’t want entrepreneurs to get too optimistic from,” he says. “Not everybody is a YouTube.”

Experienced entrepreneurs may be savvier negotiators though. The average investment size increased during the quarter, a sign that startups may be getting bid up. The average amount put into each deal increased to over $8 million, the highest it has been since 2002, and a nearly 10% more than the $7.3 million average deal size during the third quarter of 2005. “We’re seeing an up-tick in quality deal flow,” Rand says. “We’ve seen valuations trend up a little bit, but we see enough institutional memory out there to prevent valuations from getting so high to where the opportunity for return multiples is in the sewers.”

Cleantech has helped attract entrepreneurial talent. The Industrial and Energy sector, which encompasses cleantech deals, saw a more than 300% jump in investment dollars. VCs put more than $700 million into 50 companies, up from almost $175 million into 35 companies during the third quarter of 2005. There’s little doubt that innovative companies in the sector are getting bid up. Fast and furious fund-raising during the summer by firms such as Expansion Capital Partners, Technology Partners, Nth Power, DFJ Element and Kleiner Perkins Caufield & Byers is helping fan the fire.

We’re seeing a lot of first time entrepreneurs and a fair number of people coming through who made a fair amount of money a while ago and have been working on something in stealth, funding it themselves.”

Len Rand, Managing Director, Granite Ventures

The Media and Entertainment segment also saw big gains. VCs put nearly $415 million into 74 startups in the space during the third quarter, an 88% gain from the $220 million invested into 43 startups during the same period last year.

Software was still the most popular sector for VCs to put money to work with 178 deals done in the quarter, but dollars invested slid down 4% to $1.09 billion from $1.15 billion in Q3, 2005.


The venture industry curbed its hunger for fresh capital during the third quarter, a sign that firms may be more focused on putting their money to work than in accumulating war chests. The Q3 totals were down from the second quarter of this year, when 62 funds raised $13.4 billion. They also fell below Q3 2005, when 62 venture funds raised $5.6 billion. Still, 52 venture funds raising $4.9 billion during the third quarter, according to the NVCA and Thomson Financial. The third-quarter slowdown could be a healthy moderation on what is shaping up to be the biggest year for fund-raising since the bubble.

A sizable chunk of the money raised in Q3 was either earmarked for international investments or went to funds that feature a significant global component. Matrix Partners raised $150 million for an India fund, Greylock Partners raised $150 million for an Israel fund and New Enterprise Associates raised $105 million for its NEA IndoUS Ventures India-targeted fund. Add to that DCM-Doll Capital Management’s $500 million fifth fund, of which more than one-third will be invested abroad and Partech International, which raised under $100 million and has a significant international interest.

U.S. venture funding may pick up next quarter as limited partners direct their attention toward smaller fund-raisers “We’ve been hearing from LPs that they’ve finally got time to deal with mid-market players,” says Kelly Deponte of placement agent Probitas Partners. “Now that many of the big buyout funds are closed, they have more bandwidth for other players.” That may be particularly important for VC funds looking to close. The fourth quarter may also see LPs looking to fill their venture allotment for the year, Deponte says.

Life sciences firms managed to pull together a fair amount of commitments during the quarter, with Domain Associates closing on its seventh fund, a $700 million effort, which is substantially larger than its $500 million predecessor. Meanwhile, Thomas, McNerney & Partners closed its second life sciences fund at $375 million, and De Novo Ventures closed its third fund at $300 million.

You’re seeing some interesting exits from the M&A side of things which I wouldn’t want entrepreneurs to get too optimistic from. Not everybody is a YouTube.

Clint Chao, General Partner, Formative Ventures


Life science firms found fund-raising comparatively easy since, during the first half of the year, they seemed to be about the only VCs able to take their companies public. Domain, for example, saw five of its portfolio companies go public in 2006, and it has another ready in registration.

Overall, it was a tough quarter to take a startup public. Just eight venture-backed companies raised $934.2 million through IPOs, in what was the slowest quarter since 2003, according to the Exit Poll report by Thomson Financial and the NVCA. The total was way down the second quarter, when 19 VC-backed companies went public and raised more than $2 billion. In Q3 2005, 19 venture-backed companies went public and raised nearly $1.5 billion.

“The venture-backed IPO volume has fallen to alarmingly low levels, suggesting that the public markets are not the destination they once were for emerging growth companies,” NVCA President Mark Heesen said in a statement.

The third quarter saw just a single life sciences company go public in the United States: Osiris Therapeutics (Nasdaq: OSIR) offered at the bottom of its range at $11 on Aug. 4. On the bright side, the stock was trading at more than $19 a share as of Oct. 23.

The few tech companies that managed to sneak through the tight window have also done well. Four of the five that debuted in the third quarter are trading above their offering prices. Riverbed Technology (Nasdaq: RVBD), which helps manage wide area network bandwidth, topped the charts, more than doubling its Sep. 21 offering price of $9.75 per share. DivX (Nasdaq: DIVX) was up to $23.25 in mid-October from its Sept. 22 offering price of $16 per share. Data management company CommVault (Nasdaq: CVLT) offered at $14.50 on Sept. 22 and was up to $19.25 as of press time. Outsourced printing company InnerWorkings (Nasdaq: INWK) shot up to above $14 in mid October from its Aug. 16 offering price of $9. Shutterfly (Nasdaq: SFLY) was the only VC-backed tech IPO lagging. It was trading below $13 during mid October, down from its $15 offering price on Sept. 29.

VCs are optimistic that more companies will go public next quarter. “The IPO market is opening up,” says Venky Ganesan, a manging director of Globespan Capital Partners. He cites Riverbed and Shutterfly as signs of strength. “The nuclear winter of venture capital might be thawing,” he says. “I smell money in investment banker’s voices.”

I smell money in investment banker’s voices.”

Venky Ganesan, Manging Director, Globespan Capital Partners

Many venture capitalists have blamed Sarbanes-Oxley for putting up too high a barrier to becoming public. But even that may be changing. Says Rand: “There’s optimism that the feds will do something to wash away the most ridiculous aspects of Sarbanes-Oxley to avoid the market getting washed away to AIM [London’s Alternative Investment Market].”


With IPO liquidity limited, VCs have increasingly turned to strategic acquirers to step in and salvage their portfolio plays. Still, those numbers took a downturn in the third quarter as buyers picked up 74 venture-backed startups for a disclosed value of $2.7 billion in the third quarter, according to Thomson Financial and the NVCA. Those figures were down from the second quarter of this year, when 91 VC-backed startups were acquired for a disclosed value of $3.74 billion. The Q3 total was also down sharply from the same period a year earlier, when 98 VC-backed companies were snapped up for a disclosed value of $4.37 billion.

The biggest deal of the quarter was Gilead Sciences’ $419.5 million buy of Corus Pharma, a Seattle company that was developing respiratory drugs. Gilead invested $25 million in the startup in April.

But the fourth quarter acquisition market is off to a strong start with Google’s stock purchase of video-sharing site YouTube $1.65 billion in stock in early October. And there is continued speculation that Yahoo may buy Facebook for as much as $1 billion.

That interest may help open bankers’ eyes to the potential gains from early stage acquisitions and could even help launch a flurry of smaller deals. “The investment banks, including the boutique investment banks haven’t moved downstream to earlier opportunities as quickly as the value would merit,” says Roden of The Angels Forum. “That’s going to change, but not too many people have gotten the wakeup call in the banking community.”