Optimism And Pessimism In A Conflicted Venture Industry; Through It All, Valuations Rise And Down Rounds Largely Do Not

Venture deal volume has slowed. But valuations creep higher. And while many venture capitalists anticipate investing will fall in 2012, they see brightening exit markets for IPOs and M&A.

These conflicting views are evident in a venture industry decidedly less optimistic than a year ago and unsettled by the economic realities of a trying year just ending. The divergent views were evident in a pair of reports released yesterday and today.

The first comes from the law firm Cooley and found that deal volume at the firm fell in the third quarter. The firm handled 85 deals in the three-month period, representing about $1.2 billion in invested capital, down from 125 deals and $2.3 billion in the strong second quarter. Such a tail-off is not surprising given the public market gyrations of the summer and early fall.

What is surprising is that median pre-money valuations rose across all deal stages and particularly so for Series A, where they reached $10.5 million, a level not seen since 2007.

What’s more, up rounds held steady at 70% of deals, compared with 74% in the second quarter, Cooley found. The big picture may be dimming, but VCs like their own deals!

Also of note in the Cooley study: the use of liquidation preferences greater than 1x fell in all deal categories as did the inclusion of pay-to-play provisions.

Contrast this with the outcome of the annual look ahead survey from the National Venture Capital Association and Dow Jones VentureSource (on this page). The study found 36% of venture capitalists in the United States expect investment dollars next year to drop while 32% expect them to rise. Consumer and health care IT will be hot, but cleantech and biopharma will not.

One consequence will be a shortage of capital for seed and early stage deals. Fifty-eight percent of venture investors anticipate this, according to the survey.

This dim outlook contrasts with a generally more encouraging outlook toward exit markets. Forty-eight percent of VCs expect 2012 to see more IPOs than this year, while only 18% expect fewer (see chart from survey above). Quality will rise as well. Forty-three percent anticipate this.

On the M&A front, 69% of GPs expect more acquisitions of portfolio companies. That doesn’t sound all that bad to me.