VCs Disagree with Survey on Valuations –

A new survey shows that overall valuations for venture-backed companies fell last year, but venture capitalists say that they’re seeing valuations increase. The one thing everyone agrees on is that health-care related deals continue to be pricey.

Medical/health and biotechnology companies had the highest valuations last year, while follow-on rounds and later-stage funds maintained their dominance, according to new year-end valuation data from Thomson Venture Economics (publisher of VCJ).

Medical/health companies had average valuations of $61.2 million in 2003, followed closely by biotechnology companies at $60.5 million. These two categories were the only industry classifications to increase in 2003 from the previous year.

Venture capitalists say they’re actually seeing valuations increase for life sciences deals. Jonathan Fleming, a managing partner at Oxford Bioscience Partners, sees the healthcare space as still on the road to recovery after being dumped as a sector of interest by many venture capital firms. He has seen valuations rise in later-stage companies due to the improved IPO market. Of the 20 venture-backed companies that have gone public this year, 14 make drugs or other therapies and two more are health-care related.

“When you do have companies getting out in the stock market, even if the prices are not especially high, it encourages people to pay up for later-stage opportunities,” Fleming says. “We’ve absolutely seen a dramatic increase in valuations, particularly at the Series B and Series C levels. They’re certainly not back to 2000 levels. It may never go back to 2000 levels, but since one year ago we’ve seen a pretty significant increase.”

Fleming cites recent pharmaceutical deals as being totems of an invigorated venture market. “When you see LBO funds investing huge amounts of capital as was done with Jazz [Pharmaceuticals, which raised $250 million and was led by buyout firm Kohlberg Kravis Roberts & Co.], I don’t expect this to stop for the rest of the year,” he says. “I expect valuations to continue rising.” Fleming notes that he doesn’t think the industry is on the verge of another bubble. “I don’t think we’re going to get irrational exuberance a la dot-coms, but there is a lot of money being put to work.”

For 2003, the valuation for a typical venture deal averaged $36.1 million, a decrease from $39 million in 2002 and the all-time high of $84.6 million in 2000. The rate of decrease has been slowing down since 2000. For example, the average valuation fell by 34% in 2001 and by 30% in 2002 before declining by just 8% in 2003.

The numbers sound good, but they don’t jibe with what venture capitalists are seeing right now. “The tough years from 2001 to 2003 have people kind of hungry for success and that may have driven up the prices,” says Bob Pavey, a general partner with Morgenthaler Ventures. “What I forecast to our limited partners is that it is still going to be choppy seas for another couple of years. You’re going to continue to see valuations go through ups and downs for a while.”

How you view the valuation data depends on where you reside in the venture capital process.

IRR Impact

For GPs who have been investing since the zenith in valuations, lower valuations produce lower internal rates of return for investors, meaning interim results may be lower than anticipated.

Limited partners for the most part have embraced lower valuations as part of a larger transparency issue, as many have felt that GPs were reluctant to reduce valuations below cost, which would lead to artificially high returns data. In addition, for those general partners currently investing the decline in valuations from the peak in 2000 is good news in that it forms a lower cost basis on which performance will ultimately be measured.

By industry, health care and life sciences were the only segments that saw a spike in valuations. The average valuation for computer hardware companies dropped from $39.9 million in 2002 to $15.2 million in 2003. This plunge was the largest both in dollars and percentage terms.

Communications and media companies had the fourth-highest average valuations, with $34.3 million. However, from 2000 to 2002, this sector ranked first, while in 1999 it had the second highest.

For 2003, the average valuation for companies receiving first-round financings was $10.3 million, down substantially from an average of $18.5 million the prior year.

The average valuation for follow-on investments was $42.1 million last year, down from an average of $45.8 million in 2002.

The gap between follow-on valuations and first-round valuations decreased each year between 1999 and 2002. But in 2003, the difference between the two valuation figures increased, so that the average valuation for follow-on financings was more than four times that of the average first-round valuation.

By vintage year, older funds investing in 2003 experienced higher valuations. For example, 1999 vintage year funds invested in companies with an average valuation of $64.1 million, while the companies receiving investments in 2003 from 2002 vintage year funds had an average valuation of $43 million.

In general, the investments of older funds had higher valuations than those of more recent vintage years. This was presumably because the investments of older funds tended to be follow-on financings of companies that received financing prior to 2003.