Venture Capital Sees Deal Uptick After Dismal Year

Venture capitalists started sinking more money into companies in the fourth quarter, an early indication that they’re feeling more confident than they did during most of 2009—an overall disastrous year for the venture sector that fuels many entrepreneurial companies.

Two reports, the MoneyTree report by PriceWaterhouse Coopers for the National Venture Capital Association, and one by Dow Jones VentureSource, report slightly different numbers. But the bottom line is a dealmaking uptick in the last quarter of the year, after a disastrous 2009.

The NVCA report released this morning shows Venture capitalists invested $17.7 billion in 2,795 deals in 2009, the lowest level since 1997.

The health of venture capital deals is hugely important to the overall economy and especially to entrepreneurs trying to get their companies going. Venture-backed companies account for 12 million jobs and 21 percent of the gross domestic product, the NVCA estimates.

And at least the fourth quarter could be seen as good news for a sector that just about everyone expects to see contract, but one that is key to the health of entrepreneurial companies. The NVCA report based on data from Thomson Reuters showed that the number of deals, 794, was an increase of 15.1 percent in the number of deals from the third quarter.

Dow Jones VentureSource numbers are slightly different, but also show some improvement in the fourth quarter after a dismal year. VCs invested $6.3 billion in 743 deals in the last quarter of 2009, a slight improvement from the $6.1 billion invested in 619 deals during the same period in 2008. Throughout 2009, VCs invested $21.4 billion in 2,489 deals, a 31 percent drop from 2008’s $31 billion invested in 2,817 deals, according to Dow Jones VentureSource.

The increase in the fourth quarter reported by VentureSource this morning is compared to the fourth quarter of 2008, when the financial industry all but collapsed. And the higher fourth-quarter investment numbers come after a year during which VCs made fewer investments for less money in older companies than they had in the past, according to the report released by Dow Jones VentureSource this morning. In other words, VCs spent last year keeping companies alive rather than putting their money to work helping drive new company creation.

“Venture capitalists are still treading lightly when making investments,” said Jessica Canning, global research director for Dow Jones VentureSource. “In the fourth quarter, venture deal activity returned to levels seen before the collapse of the financial markets, but capital invested continued to lag as investors gave companies just what they need to reach the next milestone.”

The biggest percentage of the money venture capitalists put to work in 2009 was with later-stage companies, according to VentureSource. Thirty-nine percent of investments were with those companies.

But Mark Heesen, president of the NVCA, said he expected that trend to change in the coming year.

"The venture capital industry had no choice but to slow the investment pace in 2009," Heesen said. “The weak exit environment resulting from an unstable public market combined with a challenged limited-partner base sent a strong message to the venture community to pull back the reins—and the VC's listened. Now that the economy has begun to show signs of improvement, we expect to see dollars flow more freely back into those sectors that offered the most promise before the recession began—clean technology, life sciences, and IT. The seed and early-stage pipeline needs replenishing across all industries, and the health of the startup community in the next decade will be dependent upon more robust first-time financings. 2010 should be the year to begin that process in earnest."

Still, the 2009 numbers—whether you look at Dow Jones VentureSource or Thomson Reuters numbers for the NVCA—paint a grim picture of the past year, one in which venture companies pulled back deals, had a harder time raising money for deals, and had a harder time selling their shares in companies and cashing out either through mergers and acquisitions or initial public offerings.

Venture firms raised $15.2 billion for 120 funds from the endowments and wealthy individuals that make up their limited partners. That’s a 47 percent decline from 2008. By number of funds, 2009 was the worst year for VC fundraising since 1993.

That fits with a picture most venture capitalists are painting for the future of their industry, one with a smaller number of larger funds that are very careful with the investments they make in emerging companies.

But against that backdrop, the numbers reported by Dow Jones this morning can only be seen as encouraging. They mean that even against the tough current, VCs were out there doing deals with companies.

And what kind of companies did VCs like best in this past year?

According to VentureSource, health care topped the list, with $7.7 billion going to health care companies in 701 deals. Energy saw the swiftest contraction after a record 2008, raising $1.2 billion in 87 deals in 2009, a third of the $3.7 billion raised in 118 deals in 2008.

"Venture capitalists’ shift away from capital-intense deals, such as funding large energy projects, toward capital efficient deals, like energy-efficiency plays, contributed to the steep decline in venture investments in the energy and utilities industry,” Canning said.

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Kent Bernhard Jr. is News Editor of Portfolio.com