Q1 was a big downer for valuations

Most venture-backed companies that secured follow-on investments in the first quarter did so at flat or lower valuations that in previous rounds, according to a new report.

The Fenwick & West Venture Capital Survey, released last week, found that down rounds accounted for 46% of follow-on financings at Silicon Valley-based companies in Q1. Up rounds comprised just 25% of deals, and the remaining 29% were flat.

Overall, it was the highest proportion of down rounds since the first quarter of 2003 when the wake of the dot-com implosion affected many valuations.

This past quarter declines were more widespread. Companies in all sectors and stages posted declining valuations, says Barry Kramer, a partner at Fenwick & West and co-author of the study.

However, Kramer says that he found a mild positive indicator in the data: The proportion of up rounds was lowest in January, and increased some in February and March.

“There was some feeling that Q1 was the worst quarter and that things are going to get better,” Kramer says.

Kramer adds that the second quarter is shaping up as stronger period for venture industry returns, because a few IPOs have launched this quarter and the Nasdaq is up. However, he’s not entirely optimistic, noting that any recovery “is really tenuous, and a lot of bad things can happen in the interim.”

The 92 Silicon Valley companies included in the survey saw their average share price decrease by 3% in Q1 compared to their prior financing round. That marked the first decrease since Fenwick & West began tracking that metric five years ago.

In the prior quarter, the average share price increased by 25 percent.

Venture investment dipped in the same period, as well, with investors putting just $3 billion to work, down from the $5.7 billion that was invested in the fourth quarter, according to the MoneyTree Report from PricewaterhouseCoopers and the National Venture Capital Association based on data from Thomson Reuters (publisher of PE Week).

Another trend Kramer has seen in the past couple of quarters is an increase in enforcement of “pay to play” provisions, in which existing investors who don’t participate in follow-on rounds may see their stakes diluted or their preferred shares converted to common stock.

About 14% of financings in the first quarter had pay-to-play provisions, according to Fenwick.

Kramer says he also suspects that a large portion of reported flat rounds are actually insider rounds. In these deals, because existing investors are the only ones putting in new money, they agree to apply the same terms used in the prior round, he says. —Joanna Glasner