Life is stirring in the venture capital market again. The recent flow of IPOs, a spate of acquisitions and more reasonable corporate valuations have boosted venture capital activity.
It has been a long time coming. After skyrocketing to $20 billion-plus levels in 2000, venture investment dropped every quarter thereafter, bottoming out at $4.1 billion in 2003’s first quarter, according to Thomson Venture Economics (see graph). The losing streak ended in the second quarter, when venture funding rose to $4.5 billion. Though it slipped to $4.2 billion in the third quarter, venture capitalists and entrepreneurs believe the worst is over.
“It feels so exciting again,” says Thomas Banahan, one of four managers of the Lehman Brothers Venture Partners 2003 Fund, which raised $300 million in October. “There’s a tremendous amount of money sitting on the sidelines, but it’s starting to get aggressive.”
Just ask Louis Breton. He’s a founder of Cellz-Direct, a Tucson, Arizona, biotechnology con- cern that raised $2.1 million in October. “The outlook for companies to raise money is actually quite good,” notes Breton. It just takes longer to raise cash now, he says. “My advice is to go out looking before you need the money.”
One reason Cellz- Direct attracted venture capital attention is that biotech has been leading the revival in venture-backed IPOs, which allow venture capitalists to exit their investments. Nine venture-backed companies went public in the third quarter, raising $732.8 million. Among the hottest: Neurochem, maker of an Alzheimer’s disease drug, which has risen nearly 50 percent since its September 18 IPO. In the previous four quarters, there were only eight such deals.
Another exit ramp for venture capitalists, M&A, is open to at least some traffic. In the third quarter 74 venture-backed companies were acquired, according to Thomson Venture Economics and the National Venture Capital Association, an industry trade group. That’s only one more transaction than in the second quarter but a heartening pause in the steady decline of the past couple of years. And the value of these deals rose about 14 percent, to $2.1 billion, during the quarter.
Venture capitalists can also wrangle far better terms from fledgling companies than they could two years ago. Valuations of venture-backed companies fell at least 65 percent from 2000 to 2002 and have recently flattened out, according to Thomson Venture Economics.
Yet venture capitalists remain cautious about writing checks, forcing entrepreneurs to meet tougher standards. Consider Richard Tworek, founder and CEO of Qovia, a Frederick, Maryland, maker of Internet telephony systems that raised $5.5 million in October. Tworek says he did a lot of work identifying his market segment and building a management team before seeking funding. “You can’t follow the hockey puck anymore,” he notes. “You have to skate in front of it and anticipate where it’s going, to be able to hit it into the net.”
Opinions about what makes an appealing product may also be changing. For example, Peribit Networks, a Santa Clara, California, network technology company, successfully raised $10 million in October because it’s “selling a product that saves money,” explains CEO Jef Graham. Peribit’s technology enhances network capacity, an alternative to costlier upgrades. "[Today] your product can’t be about improving performance. It’s got to be about saving cash,” Graham says.
As heartening as the dawn of a new investment cycle may be to venture capitalists and entrepreneurs, no one’s expecting an instant revival. Says Jesse Reyes, U.S. director of Thomson Venture Economics, “It’s going to feel better, but we’re not talking orders of magnitude -- yet.”
