Venture investment dips in Q3

Investment in venture-stage companies dipped moderately in the third quarter, amid a sharp decline in funding of Internet startups and a modest rise in biotech deals.

Overall, venture firms invested $7.1 billion in 907 deals during Q3, according to the MoneyTree Report from PricewaterhouseCoopers (PWC) and the National Venture Capital Association (NVCA), based on data from Thomson Reuters (publisher of PE Week). Quarterly activity was down 7% from Q2, when VCs invested $7.7 billion in 1,033 deals.

Researchers say declines are likely to intensify with the broader economy weakening.

“While overall venture investing hasn’t yet been impacted by the turmoil in the financial markets, as evidenced by the $7 billion plus invested in Q3, we do expect to see a dip in investing over the next several quarters,” says Tracy Lefteroff, managing partner of the venture capital practice at PwC.

Looking ahead, NVCA President Mark Heesen says he’ll be closely tracking data on first-time financings—a key indicator of the health of the venture industry.

During the third quarter, the dollar value of first-time deals (startups raising venture capital for the first time) declined 12% to $1.5 billion

“If venture-backed companies can’t exit due to continued poor market conditions, venture firms will have to commit additional time and unplanned follow-on rounds of financing to those existing portfolio companies, which will channel resources away from new deals,” Heesen says.

Heesen adds that cleantech is likely to consume a larger share of venture investment going forward. He predicts it could become the top investment sector for the venture capital industry by 2012.

For now, venture investors appear to be favoring certain sectors and cutting back investment in others.

In the third quarter, biotechnology, software and energy ranked as the top three industries for venture investment. Of those, biotech topped the list, with $1.35 billion invested in 114 companies. Software was a close second, with $1.34 billion invested in 214 companies.

Companies in the industrial and energy sector, which includes cleantech, raised $1.2 billion spread among 96 deals.

By far, the largest rounds went to solar companies. SolarReserve Inc., a developer of utility-scale power plans, raised $140 million in venture funding in the third quarter. AVA Solar Inc., a manufacturer of thin film photovoltaic modules, raised $104 million from investors.

After that, the next-largest rounds went to life sciences companies. Pacific Biosciences of California (f.k.a. Nanofluidics), which commercializes nanotechnology for application in biology, raised $100 million. CVRx Inc., a developer of implantable devices to control hypertension, raised $84 million.

While they bulked up on biotech, venture firms sharply reduced funding for Internet companies. In the third quarter, VCs invested $1.1 billion in 194 deals, a 36% decline in dollars over the second quarter. Meanwhile, the telecommunications industry, with $323 million invested in 45 deals, sunk to its lowest quarterly investment level in 11 years.

Venture investment in India by U.S. venture capitalists also declined significantly in the third quarter, falling to $271 million, a 43% drop from the second quarter. Investments in China also declined some, as it totaled $526 million in Q3, down from $574 million in the previous quarter.

VC investments remained broadly diversified among early, expansion and later stage deals in the third quarter. Seed and early stage deals accounted for the largest portion, with 39% of total deal volume, up from 37% in the second quarter.

Later stage deals provided about one-third of investments, while expansion stage rounds generated just 29% of deals in the quarter, the lowest level in the history of the survey.