Europe Falls Behind Silicon Valley In VC Deal Flow

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Europe Falls Behind Silicon Valley In VC Deal Flow

via WSJ.com: Venture Capital Dispatch on 7/23/09

Just how bad is the venture capital situation in Europe?

The San Francisco Bay area, which encompasses Silicon Valley, actually saw more venture funding deals in the second quarter than in all of Europe, the first time that has happened in a quarter on record, according to research firm VentureSource.

That's not due to any special rebound in Silicon Valley. While investment there improved in the second quarter from the first like the rest of the overall U.S., the number of deals, 180, and amount of money, $1.83 billion, were still the second lowest totals since the third quarter of 2003.

Instead, it's because Europe's venture capital scene is rapidly shrinking. Some firms have recoiled or pulled out of venture capital completely, like Europe's largest investor, 3i Group, did this year to focus solely on growth equity and buyouts.

In the second quarter, Europe's deals fell for the fourth consecutive quarter to 156, or 24% below the first quarter, while investment dropped 31% quarter-to-quarter to EUR619.7 million ($880.6 million), less than half the amount in the San Francisco Bay area.

In fact, Europe's totals for the quarter were the lowest since VentureSource began reporting on the region in 2000.

"Lots of venture capital firms [in Europe] are focused on their portfolio companies and have little appetite for new deals," said Jean Schmitt, a managing partner with Paris-based Sofinnova Partners.

Schmitt said U.S. firms are "gone from Europe," and the secondary market is even having an effect. "The secondary market is extremely big in Europe right now, even good [venture] firms are focusing on secondaries," pulling money away from new deals and into old ones, he said.

The situation isn't a whole lot better around the world. (See several charts below.) While venture capital investment recovered somewhat in the U.S. during the second quarter, the amount of money fueling international start-ups continues to slide after an already tumultuous drop in the first three months.

According to VentureSource, second-quarter investment and deals fell not only in Europe, but also in Canada, China, and India, suggesting many U.S. venture firms with an international presence are focusing more of their time and money on portfolio companies here. Only Israel, the other area that VentureSource tracks, showed some quarter-to-quarter improvement but the first quarter was its weakest on record. (See charts below.)

In the U.S., venture investors put $5.27 billion in to 595 deals in the second quarter, a noticeable advancement from the first quarter but, like everywhere else, still down compared to a year ago. In the international countries that VentureSource covers, 250 deals brought in $1.46 billion, less than the 303 deals and $1.99 billion recorded in the first quarter.

In China, investment fell for the fourth consecutive quarter to $282 million, the lowest total since the fourth quarter of 2005 when many U.S. firms began investing over there. That amount was 80% less than the unusually large $1.39 billion recorded in the year-ago second quarter. Investors made as many deals as in the first quarter, 33, but less than half of last year's total.

Benjamin Feng, president and general partner for Pac-Link Capital in Shanghai, said the financial crisis has caused venture capitalists to allocate more time to managing their portfolios. With the capital markets closed, "investments do not look attractive at all," he said.

As for a recovery in China, Feng remains cautiously optimistic: "The stock market seems to be saying it will end soon. I am more cautious. China will do better and recover faster than the rest of the world."

Information technology companies in China raised $124 million from 16 deals, about in line with the $130 million and 16 deals from the first quarter but well below the year-ago period when $957 million was raised from 34 rounds. (That year-ago amount included a $430 million investment in Internet conglomerate Oak Pacific Interactive.) Health care, an emerging sector in China, didn't waver in the quarter, with six deals and $64.7 million, compared with six deals and $57.4 million a year earlier.

Over in India, where investment there has been rising precipitously over the past few years, venture capitalists have slowed down their deal flow. Indian companies raised $88.5 million across 12 deals, compared with $259.7 million and 20 deals a year ago, and $125.3 million and 13 rounds in the first quarter. There was only one deal in the information technology segment, compared with nine in the first quarter, but five consumer services deals after none during the first three months.

Israeli funding bounced back slightly after experiencing its worst quarter on record. Thirty-seven companies generated $190.8 million, compared with 33 companies and $171.7 million in the first quarter. That's still way down from 62 companies and $570 million in the year-ago second quarter.

Finally, the Canadian venture capital market continues to show signs of distress as many venture firms have failed or joined forces, creating what the Canadian Venture Capital Association has deemed a funding crisis. Here, just 12 companies raised $65.3 million, less than half the $142 million that was put into 22 deals in the year-ago period.

-Scott Denne and Jonathan Shieber contributed to this report