Q3 numbers drop across the board

VCs have been nonplussed about the turmoil on Wall Street, yet preliminary data show both venture investment and exits slowed during the third quarter of the year.

Rackspace Hosting (NYSE: RAX) was the only venture-backed company to go public during the third quarter, raising $187.5 million. The company offered at $12.50 per share in August and was trading at just above $8 per share at press time.

The quarter continued what is shaping up to be one of the most disappointing years for venture capital since the dot-com downturn. Rackspace is one of just six VC-backed IPOs all year, down from 86 the year before, causing some VCs to take a serious look at what can be done to turn the tide.

“IPOs are like the Nile River of the venture business. No Nile, no life,” says Venky Ganesan of Globespan Partners. “The venture capital business cannot exist in the long run without a vibrant market for IPOs.”

Reasons for the IPO downturn abound. Some blame Sarbanes-Oxley legislation for increasing the administrative costs associated with being public.

“We have a couple companies in the portfolio that are within striking distance of $15 million of annual EBITDA, in some cases growing 100% year over year…but the CEOs have no desire to go public, at least not now, because of the added costs and scrutiny,” says Ian Sigalow of Greycroft Partners. “This is a purely structural regulatory issue.”


No matter the cause, one thing is for certain. The lack of IPOs and exits is slowing the pace that VCs are committing their cash.

Investment numbers won’t be finalized for a few more weeks, but preliminary figures from Thomson Reuters (publisher of PE Week) report that just $5.7 billion was invested in 628 U.S.-based companies last quarter, compared to more than $7.82 billion that VCs invested in 978 U.S.-based companies during the same quarter in 2007.

That number is sure to rise as Thomson Reuters receives more quarter-end surveys from National Venture Capital Association member firms. Still, the investment numbers are likely to fall short of the $7 billion mark that the VC industry has consistently managed to hit in each quarter since the end of 2006.

Perhaps more telling is the decrease in the number of companies receiving financing. When the economy trends down, there’s typically a pull back on deal sourcing as firms double down on the most promising companies already in their portfolio. That drove up the average deal size to $9 million during the third quarter, up from $7.5 million in the second quarter.

The increased deal size may also be the product of increased activity from “growth” funds with lots of capital to deploy.

Some of the biggest investments during the quarter went to solar companies, continuing a year-long trend. Three of the quarter’s biggest deals went into the solar technology sector.

Solar Reserve raised $140 million, AVA Solar raised $104 million and Recurrent Energy raised $75 million in funding last quarter. Other cleantech companies raised large rounds of funding, too, including electric car maker Fisker Automotive, which raised $65 million, and gasoline-from-algae company Sapphire Energy, which raised $50 million from investors.


VC firms also had a tougher time closing on funds during the third quarter, raising $10.1 billion, down more than a third from fund-raising during the same quarter last year, according to preliminary data from Thomson Reuters.

A handful of growth funds buoyed the financing numbers. Sequoia Capital raised two growth funds for a combined total of $1.6 billion during the quarter. The firm closed on Sequoia Capital U.S. Growth Fund IV at $930 million and Sequoia Capital India Growth Fund II at $725 million.

Other growth funds raised during the quarter include Aisling Capital III, which raised $579 million toward its $750 million target, Versant Venture Capital IV, a $500 million fund and Kennet III, which raised $315 million.

Growth funds have become increasingly popular for firms that can raise them. Many are able to invest in both private and public companies and provide large fees to the VCs involved.

The early stage firms that closed on big funds during the third quarter had the benefit of experience. Mayfield Fund, U.S. Venture Partners and InterWest Partners each added another fund to a string of investment vehicles spanning more than 25 years.