NEW YORK – Are you sitting down?
Venture capitalists might have been too preoccupied closing hefty deals to keep tabs on everyone else’s investments, but the industry put to work an unprecedented amount of capital in the third quarter of this year: $12.98 billion.
Add on the other two quarters, and VCs invested $28.78 billion in the first nine months of this year. At press time the year-to-date total was $31.46 billion, according to Venture Economics Information Services (VEIS), a sister company to VCJ . That’s right: $31 billion in just over 10 months. Even without counting the last two months of the year, VCs wrote checks in the first 10 months of 1999 amounting to more than twice the $14 billion invested in all of 1997.
But to really put the third quarter’s remarkable run in perspective, consider that a “mere” $19 billion was invested in all of 1998.
The third quarter far outpaced the second quarter’s $9.51 billion and the first quarter’s $6.29 billion, figures that now seem downright puny.
Let us pause with misty-eyed nostalgia to remember the dawn of the Internet in the mid-1990s, when venture investments totaled $5.8 billion in 1995 and $9.9 billion in 1996.
Today we live in a dotcom-driven venture world, where the winner often is the fastest growing consumer-oriented e-commerce company able to capture market share. But that takes big bucks.
Ask Steve Baloff, a general partner at Advanced Technology Ventures. Just before Halloween, a five-month-old ATV portfolio company, PetStore.com, raised a $97 million second round of financing from venture capitalists and corporate backers. Even in today’s market, that deal is unusually big, Baloff acknowledged, although $50 million rounds are not considered unusual anymore.
The Discovery Channel is one of PetStore’s new investors, an ideal partner with its “Animal Planet” show, Baloff noted. Indeed, corporations are playing bigger and more aggressive roles as venture investors, he said. Corporate VCs forked over $2.13 billion in the third quarter, a huge jump from the $1.1 billion that corporations put up in all of 1998, according to VEIS.
Jim Breyer, whose firm, Accel Partners, invests closely with companies such as Microsoft Corp., Dell Computer Corp., Cisco Systems Inc. and Intel Corp., expects corporations to remain big players. “They’re not going away,” and entrepreneurs don’t want the corporations to go away,” Breyer said. “In many cases, the entrepreneurs are specifically tasking us with setting up the right relationships far earlier than ever before.”
More Money for Marketing
Although most deals are not in the $100 million range like ATV’s PetStore.com second round, bigger rounds are becoming more common. Indeed, in the third quarter of this year, 148 companies raised rounds of $20 million to $50 million each, raking in $4.2 billion. In 1998, only 119 companies raised that kind of cash in a single round, totaling $3.2 billion.
Not surprisingly, overall deal sizes were up in the third quarter to $11.5 million, compared with the $7 million average deal size in 1998, according to VEIS.
The reasons for the increases are multiple. Valuations are up. Dotcom companies – especially those targeting the consumer market – are determined to attain customers quickly through expensive advertising and marketing campaigns. Deal flow also is up, VCs said.
“Today we see very few venture deals where the initial investment is under $5 million. Second rounds in many of the most explosive market segments, such as communications or business-to-business e-commerce, are often $20 million to $40 million,” Breyer said. “The good news is that for the successful companies in these segments, the upside is dramatic. The bad news is clearly that the capital efficiency of companies becomes more important than ever.”
A company that has to raise $50 million before becoming profitable must secure the capital at a high valuation to avoid dramatic dilution, Breyer explained.
Even for early-stage opportunities, Breyer has seen pre-financing valuations double or triple in recent years. What would have been a $3 million pre-money deal two years ago would be a $10 million pre-money deal today, he said, adding that an average round of financing at his early-stage firm is now $10 million.
“We’ve probably made 27 investments this year, including some seed investments, which is clearly a faster pace than normal,” Baloff said.
Part of the reason is a dramatic increase in deal flow. Baloff sees the Web having a democratizing effect on entrepreneurship, opening the doors to non-technically inclined innovators who would have been normally shut out from starting a company. The reason is that Internet companies – especially e-commerce enterprises – are not differentiated by their technology; rather, the success of such companies rides on the experience of managers coming from relevant backgrounds and the young enterprises’ ability to attract employees with dotcom experience. “It’s opened up the world of start-ups to a whole class of people who weren’t able to do it before, and as a result, we’ve seen this torrent of new business ideas, many of which are quite interesting.”
Breyer agrees, to an extent. In the end, how well technology is delivered to customers factors into a company’s success, he said.
The Internet Rules
It is inevitable that a discussion about third quarter disbursements focuses heavily on the Internet. Indeed that sector, along with computer software and services and communications ate the other sectors’ lunches.
Of the $12.98 billion doled out in July, August and September, $5 billion – 39% – went to Internet enterprises. Almost $2 billion (15%) flowed into software and services, while $1.92 billion (15%) was invested in communications. That means of every $10 in venture money put to work in the third quarter, about $7 went into one of those three industries. The remaining $3 were parceled out to other sectors, including health care, biotechnology and consumer computer hardware.
While dwarfed by the Internet’s screaming headlines, the news was good for consumer companies. Disbursements grew steadily over the first three quarters of 1999, and the total dollars invested in consumer companies in January through September – $1.6 billion – beat 1998’s total of $1.3 billion.
Venture investing on the health care and biotechnology fronts was more modest.
Medical and health enterprises took in $841 million in the third quarter, totaling $1.9 billion in the first three quarters of 1999. In 1998, the sector took in $2.38 billion so to match or exceed last year’s figure, the medical/health sector would have to see at least $468 million invested in the fourth quarter.
Biotechnology companies garnered $237 million in the third quarter, less than the second quarter’s $285 million but more than the first quarter’s $215 million. Last year, biotech brought in $966 million, and the industry would have to snag at least $229 million in the fourth quarter to meet or beat last year’s total.
“It’s not that health care is bad, it’s just that the Internet is just extraordinary,” said Stan Fleming, a partner at health care-focused Forward Ventures.
“If you just look at what we’re doing, we’re still working for a living over here … things have been slow, but the window seems to be opening up a bit, and there’s plenty of deal flow,” he observed.
Unlike his Internet-oriented brethren, Fleming has not seen valuations in his sector rise. Plus, the health-care industry is big and has tremendous inefficiencies, making it a good industry to back, he pointed out.
Deals that return 10 or 20 times a VC’s money are good by VC health care standards, he said, but that is quite a bit less spectacular than the returns generated by IT homeruns. Nevertheless if health-care investors can go back to limited partners with 25% returns or higher, “there should be a place at the table for you.”
Fleming expects health-care disbursements to increase in the near future. “There’s lots of work to be done; there’s lots of returns to be made.”
ATV’s Baloff does not expect the disbursement pace to slow on the IT side: he said the fourth quarter likely would be more of what the third quarter produced.
Breyer worries about the pace of investing, the dollars flowing out from VC funds and how recipient companies use the money. To alleviate his concerns, he concentrates on honing Accel’s strategy.
“We’re trying to find areas that are not receiving as much me-too’ venture investment as some of the over-funded consumer segments,” he said.
Accel is looking at broadband-enabled products and services, business-to-business marketplace companies and business-to-business enabling infrastructure opportunities, such as portal software.
“At the end of the day, we see too many companies being financed in most segments of the business. Ultimately, this will lead to lower returns and increased competitive intensity,” he warned.