What Is Going On Out There?

The third quarter venture funding stats were released today by National Venture Capital Association (I am on the NVCA Executive Committee so am a big fan of their data) – always makes for entertaining reading. It is a little bit like looking for clues, especially in this market to help explain what the hell is going on out there. ..

The overall investment pace was quite impressive given that the quarter included a wild August in the stock market and the vacation slow down; investments totaled $6.95 billion in 876 deals. In 2Q11 there were 1,015 deals which raised $7.88 billion but in 3Q10 there were only 850 deals which raised $5.31 billion, well-below this past quarter. It feels like the VC industry is on pace to invest close to $28 billion this year, which continues to baffle me as VC’s will struggle to raise $15 billion in new funds. This will be the third consecutive year when the industry invested meaningfully more than it raised. That will probably end badly.

Couple of interesting observations I pulled out of the data with my calculator…

  • Notwithstanding the buzz around seed investing, as a percent of total activity it was down notably this past quarter – only 3% of investments ($178 million) was seed versus 6% ($303 million) in 3Q10. There was $403 million invested in seed deals in 2Q11 more than twice this quarter.
  • Average size of each seed round was $2 million – doesn’t really seem like seed investing to me! Average size of first rounds (“Early”) was $5.7 million.
  • Life science investment activity is decreasing substantially – in large part to capital intensity and regulatory uncertainty. I would argue that as larger life science funds pull back or give up altogether, early stage investing will quickly follow suit. In 3Q11 life science investment was 28% of the total activity; this was 32% in 3Q10. Watch for this to get worse before it gets better.
  • Since 2Q11 life science investing decreased 13% on a dollar invested basis. Cleantech also witnessed a meaningful decline.
  • Software rocked this quarter – $2 billion was invested in 263 deals. Quite clearly investors are rotating out of sectors with long and uncertain development pathways to ones with revenue and nearer term liquidity options.
  • An interesting VC risk barometer is the amount of “first time” financings and the news is not so good here. As a percent of all dollars invested, only 17% were “first time” ($1.2 billion) versus 20% in 2Q11 and 24% in 3Q10 – clearly a negative trend and most likely reflecting increasing risk aversion and many funds who fear not being able to raise new funds, just doing what looks safe. It is even more dramatic when focusing on “first time” seed investments which were 10% in 3Q11 down from 22% in 2Q11. My guess is we are beginning to see the end to the “Great Seed Experiment” – now that many companies seeded one to two years ago are hitting the wall – not every seed will raise a Series A.

I could happily drone on with more “fascinating” insights in the funding data but will pause there. Clearly VC’s are increasingly drawn to businesses which can drive near-term revenue (consumer internet/social media) and/or don’t have open-ended product development pathways (life sciences/cleantech). External forces like the hostile FDA or non-existent IPO markets are conspiring against certain VC-backed companies.

Ok, one more observation which I have been reluctant to even comment on – the ceaseless New York versus New England comparison. New York killed it this past quarter – $891 million invested in 103 deals, even better if you throw in metro Philly. New England’s results – $586 million and 108 deals – not so great. But hold on – year-to-date New England invested $2.36 billion in 324 deals as compare to New York’s $2.19 billion in 289 deals. While we very much respect the New York phenomenon – one of the Flybridge partners is there every week – hell, I am a Mets/Giants/Knicks/Islanders fan – this is a marathon, not a sprint. Anyway we think both markets can peacefully co-exist and in fact are near-perfect complements. They are only 180 miles apart.

Michael Greeley is a general partner with Flybridge Capital Partners. He blogs here and tweets here. The opinions expressed here are entirely his own.