Venture capital rebounds slightly: Is Startup Nation back?

The numbers for the second quarter of 2009 venture capital deals are in and they look surprisingly strong.

According to the MoneyTree Report from PriceWaterhouseCoopers LLP (PwC) and the National Venture Capital Association (NVCA), based on data provided by Thomson Reuters, venture capitalists invested $3.7 billion in 612 deals during the quarter. That constitutes a dollar increase in investment activity of 15 percent over the same period last year. However, the number are likely skewed upwards by a handful of very large deals in the life sciences sector and on a normalized basis VC fundings likely would not show as much improvement.
The number of deals was roughly flat. For 2009, the NVCA expects that VC investing levels are expected to mirror those found in 1996 and 1997 before the Internet bubble fully expanded. "I can't say I was very surprised. There is plenty of negative economic news out there and the venture industry as a whole has been spending a lot of time on the care and feeding of the existing portfolio," said David Jones, the managing director at Chrysalis Ventures, a Louisville (Ky.) venture fund with roughly $400 million under management.

A deeper dive into the numbers revealed gloomier pictures for various swathes of the technology universe. Internet and clean tech startups were down by 15 percent in dollar volumes from the same period the year previous. Life sciences (biotech and medical devices) investments were up a whopping 47 percent over the same period from the year before. That sector tallied $1.5 billion in total monies invested during the second quarter. But as discussed earlier in this post, the funding increase likely came from a few very large investments in the drug discovery sector, where $100 million rounds are not unusual.

While major shrinkage for any sustained period is not comfortable -- particularly not to the many VCs that have underwater portfolios and tenuous job situations -- this clearly returns the sector to a more sane level of investment. A number of influential observers, including Paul Kedrosky, have opined that the VC sector has grown bloated and needed to be "right-sized." Says Kedrosky, "This is good news, relatively speaking, for people investing in venture funds at this point, as the shrinking capital pool finally augurs improved performance in future. I would like to see more funds drop out too, but that will take time."

Much of that shrinkage has occurred in the VC hotbeds of the Bay Area and Boston vicinity. "We didn't see the bubble and we haven't seen a big reduction, either," says Jones, who primarily invests in companies in the South and the Midwest.

According to Jones, later stage ventures have been reluctant to tap capital markets at diminished valuations. And the shrinkage in funding for Internet startups is hardly surprising. Consumer-facing sites have struggled to gain traction amidst the welter of new businesses trying to grab attention on the increasingly crowded Web. Further, Net launches tend to require the least amount of funding and there has been a wholesale shift towards lean startup methodologies and away from big, heavily funded Web launches.
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