Venture Investment Likely to Fall Short in 2008

In the last few days, venture firms have begun to realize they are not immune from the credit crunch. At the end of next week, official data will arrive that will likely bear that out. Judging by early numbers indicating $5.71 billion went into startups from July through September, the third-quarter venture capital data gathered by Thomson Reuters for PricewaterhouseCoopers and the National Venture Capital Association is likely to show a drop of of about 27 percent from the same period in 2007.

That’s not great news, and it’s also likely that overall investment for the year will drop for the first time since 2003, Tracy Lefteroff, a managing partner at PricewaterhouseCoopers LLP, told Bloomberg this morning. Last year, venture firms put $30.69 billion into startups. During the first half of 2008, venture firms invested $14.89 billion, climbing to $20.6 billion if we add in the preliminary third-quarter numbers. It’s unlikely that venture firms are going to put more than $10.09 billion in portfolio companies between this month and Christmas. The last time that happened was in 2000.

Mark Heesen, president of the National Venture Capital Association, says that skittish investors are helping create a poor exit environment for VC-backed companies. So far this year there have been just six initial public offerings and 199 acquisitions through the third quarter — 72 fewer than this time last year.

“We have not seen a reduction in the number of first-time financings in the first two quarters, and we may see some lag on those deals decreasing,” Heesen says. “I believe it will be the fourth quarter that we’ll see the impact that the lack of an exit market has. I am certainly hearing anecdotally that venture capitalists are doing fewer deals.”

Venture investors aren’t the only sources of startup capital that are feeling cautious. Data out today from the Center for Venture Research at the University of New Hampshire shows that while in the first half of this year angel investments were up slightly, the number of deals getting funding was down. Total investments in the first and second quarters of 2008 were $12.4 billion, an increase of 4.2 percent over the same period last year. A total of 23,100 entrepreneurial ventures received angel funding in the first half of 2008, a slight decrease of 3.8 percent from the same period last year.

“The modest increase in total dollars and angel investors, coupled with the decrease in investments, resulted in a larger deal size for the first half of 2008,” said Jeffrey Sohl, director of the UNH Center for Venture Research at the Whittemore School of Business and Economics. “These data indicate that angels are exhibiting a cautious approach to investing in light of the recent volatility in the economy and reducing their individual risk exposure by including more angels in each deal.”

The real question is how long venture firms and angels will decide to stay on the sidelines when it comes to new investments — and how long current portfolio companies have before VCs need to consider fire sales, bankruptcies and other measures so familiar from the tech bust. I’ll hit that topic on Friday.