VC Investment Drops in Q3, More Trouble Still to Come

[qi:050] The economic crisis and uncertain stock market is taking its toll on venture capital investing, according to experts discussing the latest MoneyTree survey results on a conference call today. During the third quarter, venture firms invested $7.13 billion in 907 deals — a drop of 9 percent in terms of dollars and 8 percent in terms of deals compared to the same period a year ago, according to the report from PricewaterhouseCoopers and the National Venture Capital Association, and based on data provided by Thomson Reuters. For the same period in 2007 venture firms invested $7.82 billion in 983 companies.
But of far greater threat to venture capitalists’ livelihoods is the crummy exit market, which is leading to an increasing backlog of late-stage companies that are continuing to take up VCs’ time. The stock market gyrations haven’t helped the exit market, but there are more systemic problems as well. I’ve been pointing this out for a while, and the VC firms participating on the conference call were finally willing to admit this was a problem that may have led to fewer early- and seed-stage deals receiving funding this quarter. Seed- and first-time deals dropped 19 percent from the year prior, meaning that for every five early-stage deals VCs funded last year during July through September, this year they funded four.
Even though they may have less time for shepherding early-stage deals through, venture firms know that those investments are the fund’s future. Early investment is where the big returns are found. Yet this is another place where the market crisis is having an effect. Entrepreneurs have fewer capital resources available to them in the form of home equity, friends and family and even angels, so getting a company to the point where a venture firm wants to take a look is becoming more difficult.
Faysal Sohail, managing director at CMEA Ventures, says to counter such problems CMEA has started a program to invest anywhere from $250,000 to $700,00 in ideas to help entrepreneurs get over that initial capital hump and build a product or business plan. It’s not the first time this has been done. Charles River Partners created its QuickStart lending program back in 2006 primarily to keep its hand in with the more capital-efficient tech sector deals that were going to angels. Other similar strategies and programs include the Bay Partners Facebook fund.
For VCs, the numbers and economic turmoil are limiting the exit market even further and making it harder for entrepreneurs to get their companies to a point where they’d enter the venture pipeline. Because VCs must spend more time with their later stage companies rather than take on new startups, the pipeline on the front end is getting narrower. Essentially venture funds are being squeezed on both ends.
The net result for entrepreneurs is uncertain. While great deals will still continue to get funding — even through the crisis — the squeeze brings the entire venture model into question. Without exits, VCs can’t return cash to the limited partners who are their investors, and will then see those investors turn elsewhere. That means the venture world could get a lot smaller over the next five to 10 years.

source: PricewaterhouseCoopers/National Venture Capital Association/Thomson Reuters