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Slowdown for Venture Capital World, But Not Quite a Nuclear Winter--Yet

Kim Hart

If you've been reading the tech blogs lately, you've likely noticed the chatter about what the economic situation means for venture capital investors and the companies they fund.

Some say things feel similar to tech's nuclear winter in 2000. Others say it's simply a dip in the cycle and the strongest companies will find a way to survive. Some venture capitalists have said they will continue to raise funds and invest, waiting for conditions to stabilize. Others say they're hunkering down.

According to numbers released this morning by the National Venture Capital Association, fundraising activity slowed in the third quarter, with 55 funds raising $8.1 billion, compared to 83 funds raising $8.6 billion a year ago. The number of funds raised decreased by 29 percent over the same period in 2007.

The lower volume is not a direct result of the current financial crisis--the numbers were calculated before the meltdown of the past two weeks-- according to the NVCA, but fundraising could be impacted in the long term if large institutional investors invest less due to their own losses.

While the long-term effects of fundraising are yet to be seen, the negative impact on companies' ability to go public, and therefore giving VCs a return on their investment, has been building for some time.

In the second quarter of 2008 there were zero VC-backed exits -- on the heels of five in the previous quarter, which raised a thin $283 million. In the first half of 2007, by comparison, 43 VC-backed IPOs collected $6.3 billion, according to an NVCA report released two weeks ago.

The rate of mergers and acquisitions has also slowed down. Coupled with the lack of opportunities to go public, this will likely mean venture firms will have to extend financing to later-stage companies, meaning there will be less money available for early-stage start-ups.

This also means the companies may be more mature by the time an exit opportunity comes around again, and they may be more apt to hit Wall Street's expectations. Austere economic conditions, some investors have reasoned, makes stronger, more efficient companies.

Investors kept investing in the first half of 2008, spending about $62 million more than the same period in 2007.

This differs from the Internet bubble, "when VCs stopped investing, customers stopped buying, it was a nuclear winter," said Gregory Gretsch of Sigma Partners.

Tracy Lefteroff, global managing partner of PricewaterhouseCoopers' venture capital practice in Silicon Valley, said he doesn't see the exit drought lifting until early next year.

But he sees steady investment in the life sciences and clean tech sectors, rather than the information technologies and Web applications that received the bulk of investment in the 1990s and early 2000s. And, four of the five initial public offerings in the first half of 2008 were life science companies.

"The quantum leaps in technology have been in that side of the house," he said. "That's going to continue for foreseeable future."

There's still plenty of money out there, but investors are going to be much more cautious about spending it, he said.

So what about all those start-ups looking to be the next Google or Facebook? It's going to be a tough fight, Lefteroff said. "The market leaders have a tremendous advantage over the rest of the pack. You've got to be early to market. You've got to be a leading company or you're not going to make it."

By Kim Hart  |  October 13, 2008; 1:20 PM ET  | Category:  Kim Hart
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