Lower numbers may not be all bad

NVCA president Mark Heesen says the sudden drop in US venture fundraising in Q3 may not be such a bad thing for VCs. Dave Keating reports.

As news spread this week that venture capital fundraising fell to the lowest level in more than two years in the third quarter of 2006, analysts have seemed unsure what to make of it. On one hand, the sudden drop in fundraising coupled with lacklustre IPO activity is certainly not a welcome sign for venture capitalists. On the other, the decline may just mean that investors are wisely holding off, believing that the industry has enough money for the time being.

We think the traditional venture model clearly is broken. The feedback we’ve heard from our LPs after the cancellation has been remarkably positive, they don’t disagree.

Steve Dow, Sevin Rosen

A new report by Thompson Financial and the National Venture Capital Association shows that only 52 venture capital funds raised $4.9 billion (€3.9 billion) in the third quarter of 2006, down from the $13.4 billion raised in the second quarter. The figure represents a 13 percent decrease from the same period last year and is the least amount of money accumulated since the second quarter of 2004, when $3.3 million was raised.

That venture firms are concerned about the intense fundraising that has gone on for two years was evidenced earlier this month when Sevin Rosin, a Dallas- and Silicon Valley-based venture capital firm, took the dramatic action of cancelling its fundraising effort and returning the $250 million to $300 million it had drawn from investors for its tenth fund. Sevin Rosen partner Steve Dow says too much capital in the industry and a weak environment for exits were the main reasons for the cancellation.

“We think the traditional venture model clearly is broken,” he says. “The feedback we’ve heard from our investors after the cancellation has been remarkably positive, they don’t disagree.”

However Mark Heesen, president of the NVCA, says that venture capitalists are backing off when many believe there is too much money entering private equity is actually a good sign.

Mark Heesen, NVCA

“We’re still working off the bubble, investors are still wary of tech investing,” he says. “The IPO market is in the basement, but there is a silver lining here. 51 companies are in registration right now, which is higher than in the past, and hopefully more companies will be going public in the next three to six months.”

He says the industry is nearing the end of a three-year fundraising cycle, which will raise approximately $75 billion for venture capital firms. The money raised since the beginning of the cycle is expected to be invested during the next five to seven years. A drop-off at this time is logical, Heesen says, following the build-up that occurred leading up to the second quarter of 2006. He adds that caution by investors is not only expected, but also welcome.

The massive fundraising that took place in the first half of the year for both venture and buyout funds may also have contributed to the drop-off. By the third quarter, investors may simply just have been out of cash.

“2006 was the year of the megafund,” says one placement agent who recently closed a fund. “Those funds took a lot of the shelf space from a dollar and timing perspective, and I think that’s put the brakes on investor appetite in the second half of the year.”

Heesen says despite continued concern that lacklustre IPO performance is scaring away investment, he still thinks there are many opportunities for venture investment.

“The companies that are going public are successful” he says. “The quality of these companies is actually quite good. These are companies that made it through the bubble, they’ve beat a very tough environment.”