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Venture investors are still keeping a tight grip on their capital in the wake of the world's financial meltdown, making the third quarter of 2009 look about as anemic as the first two quarters of the year.
According to data from industry tracker Dow Jones VentureSource, VCs put $5.07 billion into 616 deals in the third quarter, which marks a 6% drop from the $5.42 billion put into 595 deals in the second quarter of the year.
If this investment pace continues, the year's total could fall below $20 billion for the first time since 1998. The first nine months of 2009 have seen a total of $14.59 billion invested.
The third quarter of 2009 looks especially paltry when compared to the same period last year when investment totaled $8.17 billion.
While some VCs were pleased that investments held fairly steady instead of falling off a cliff over the first three quarters of this year, none were willing to toss out the word "recovery."
"One quarter is a data point. Two quarters is hope. Three quarters is a trend," said Carl Stjernfeldt, a general partner at Waltham, Mass.-based Castile Ventures. "I think we are entering hope."
Castile, investing from its $100 million third fund raised about three years ago, has several early-stage investments in hardware and software companies, Stjernfeldt said.
Other investors — including several panelists at the Dow Jones VentureWire Technology Showcase in Redwood City, Calif. last week — say they expect to see a downward slide through at least next year as limited partners scale back their commitment to venture capital.
Perhaps adding to the gloomy outlook: Venture capitalists have been cautious about making new investments - or bringing in new investors to a syndicate - in an uncertain economy. As VentureWire reported recently, the rate of insider rounds jumped to 57% in the first quarter, the latest data available from VentureSource. Insider rounds climbed in the fourth quarter of 2008 as the financial crisis worsened, involving 54% of all deals versus 41% in the third period.
Within the information technology sector, the number of deals rose for the second straight quarter to 270, though that is still down from 305 in the year-ago period. Investment, meanwhile, fell back down to $1.87 billion after recovering somewhat in the second quarter when investors bet $1.94 billion. IT investment through the first three quarters is still down 45% from last year.
There was a first during the quarter within the IT sector: Information-services companies – which include a wide range of Web 2.0 start-ups – raised more capital than software companies despite fewer deals. Whereas software companies raised $581 million in 106 deals, information-services companies raised $627 million in 86 deals.
Sharon Wienbar, managing director at Scale Venture Partners, which has a large number of IT companies in its portfolio, said the news indicates that Web-based businesses are coming into their own.
"You can build a big, profitable company on the Internet now," she said. "It doesn't have to be a paradigm shift, you can value a company on revenues and profitability. Some Web companies have both."
But like Stjernfeldt at Castile Ventures, Wienbar cautioned against reading too much into a single fiscal quarter's figures. "Sometimes one large deal can make an anomaly look like a trend," she said, pointing out that the third quarter of 2009 featured the $100 million funding round for information-services powerhouse Twitter Inc., possibly making the whole sector appear stronger.
On the health care side, investment didn't surpass IT like it did for the first time in the second quarter. Instead, third-quarter totals dropped 22% from the second quarter to $2.2 billion, meaning the surge surge experienced from the first-quarter's four-year low appears to be more of a dead-cat bounce than the beginning of a recovery.
Health care deals, however, continue to climb. In the third quarter, investors participated in 184 deals, the same number reached in the second quarter of 2008 before a three-quarter slide. The latest total is up from 178 in the second quarter and 166 in the year-ago third period.
The lift in deals coupled with the slide in capital suggests that VCs may be shying away from more capital-intensive projects. Firms remain concerned about financing risk and as a result, they are still wary of placing new bets on companies that will need a great deal of capital, even if their valuations have dropped.
That theme can be seen in the capital-intensive biopharmaceutical market. These companies raised $810.9 million in 83 third-quarter financings, down from the $1.18 billion raised in 67 deals in the second quarter.
That industry, the largest health-care venture market, can't stay down forever, and some say confidence has been rising as the economy has begun to recover. "I'd say the mood is improving among biotech investors these days," said David Collier, managing director of CMEA Capital.
One sector where many have expected to see explosive growth – and have been disappointed – is in the energy sector, where a lot of small companies are working on the hot-button issue of the day: renewable energy.
Overall, the energy and utility sector raised $415 million in 23 deals in the third quarter of 2009, which is a 70% drop from the same period last year. But the sector is showing signs of life, as the second quarter of this year saw just $310 million put into 27 deals.
Renewable energy companies — which make up most of the sector — raised $343 in 14 deals, representing a 37% dropoff from the third quarter of 2008.
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