Venture Capitalists Batten Down Coffers

The next Thomas Edison may have to wait a long time before venture capitalists fund his company.

Image: Getty Images

Venture capital deals dried up in the third quarter, setting the industry on pace for its worst funding year since 2003.

Dow Jones VentureSource reports that venture capitalists invested $5.1 billion in 616 deals in the third quarter, down from $5.4 billion invested in 595 deals during the second quarter. The second quarter, weak as it was, had raised hopes that venture capitalists could be getting back to dealmaking, because it was the strongest quarter in a year. But the third quarter shows those who have been predicting fewer deals, and fewer dealmakers, as a result of the long downturn, are probably right.

“The slow recovery we’ve seen for venture capital has faltered,” said Jessica Canning, director of global research for Dow Jones VentureSource. “As liquidity and fundraising lag after the economic meltdown in 2008, investors have no choice but to keep a tight rein on investments until the industry is on more solid ground.

Last year, in the third quarter, venture capitalists invested $8.2 billion in 663 deals. But that was before the credit freeze and stock market meltdown that have profoundly affected the limited partners—endowments, pension funds, and wealthy individuals—who fill venture capital firms’ coffers with cash to invest.

And investment in venture capital shows only faint signs of a rebound. Private equity fundraising, including money raised for venture capital firms, took a nosedive in the third quarter, falling 70 percent from the same period a year ago. VC fundraising was at its lowest level since 2003. VCs raised $3.5 billion in 26 funds in the third quarter. So far this year, the venture industry has raised $8 billion across 83 funds, a drop of 58 percent from the $18.9 billion raised by 141 funds in last year’s first nine months.

Without money coming in, venture capitalists are taking great care in their investments in young companies.

They’re investing smaller amounts, in more established companies, than in the past. Later-stage companies accounted for 40 percent of the deals, and 59 percent of the money invested, while first-round fundraising made up only 27 percent of the venture capital invested in the third quarter. Last year during the same time, late-stage investments made up 33 percent of the deals, while first-round investments were 35 percent.

Information technology deals led the pack, with IT companies raising $1.9 billion in 270 deals. Health care attracted $1.7 billion in 184 deals. The renewable-energy sector, which a year ago was among the hottest, drew only $415 million raised in 23 deals.

That’s despite the fact that the biggest VC funds raised in recent months were a pair raised by venture capital legend Vinod Khosla, who pulled in $1.1 billion in two funds primarily aimed at cleantech companies.

The report comes as both cold water in the face of those who have been looking for a rebound in venture capital, and as confirmation that the industry is likely to shrink in coming years.

Successful IPOs of venture-backed companies, like that of battery maker A123 Systems, had raised hopes that the exit market for venture capital firms would improve, and with it, the rest of the industry. And word that Khosla and Netscape founder Marc Andreesen had raised funds also raised hope that the industry could get healthier.

But a few successes don’t make for a healthy industry. And the truth is, as long as venture capitalists have trouble raising money themselves, they’re going to be mighty slow to dole it out to entrepreneurs with dreams and business plans.