Payoffs Harder To Come By, But Silicon Valley VC Money Still Flows - InformationWeek

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8/19/2008
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Payoffs Harder To Come By, But Silicon Valley VC Money Still Flows

VC money has been flowing, but money going into the startup pipeline is now failing to come out the other end, and IPOs have dwindled significantly.

Despite a downturn in the economy, startups that sought an additional round of financing in the Silicon Valley recently showed an increase in value of an average of 53% over their previous financing round.

By the standard of the Silicon Valley's "venture capital barometer," a measure established by the Mountain View, Calif., law firm of Fenwick & West, a gain of 53% is a healthy return and cause for continued investment. Between one year and 2-3 years typically elapse between rounds of financing, so the barometer indicates only a loose measure of how well startups are faring.

If startups continue to appreciate as they go through rounds of financing, that's likely to keep the spigots of venture capital open and a stream on new ideas and new products flowing into the technology marketplace.

So far, despite dark clouds on Wall Street, the money has been flowing, though not quite at last year's pace. Over the last five quarters, venture capital investment per quarter has dropped from $7.9 billion to $6.9 billion, said Barry Kramer, one of the Fenwick & West partners who over sees the research that goes into the venture capital barometer. "It's been going down each quarter, but it's not fallen off a cliff," he noted. More troubling is the way that money going into the startup pipeline is now failing to come out the other end. As a startup matures by bringing its product or service to market and gaining customers, it can become highly profitable, go public, or get acquired by a larger company. "There were zero IPOs in the second quarter, none. It's never been worse," said Kramer in an interview.

Venture capitalists are still willing to invest "but there's no liquidity at the other end. How long can that go on?" asked Kramer. At the moment, large companies are less inclined to buy up small ones in stock deals when their own (large company) stock price is down; that means it takes more of their stock to do the acquisition.

Kramer thinks the 53% average increase in value between funding rounds disguises what is a time of rapid appreciation for those companies focused on Web. 2.0 technologies and "clean tech" companies with ideas for producing more energy in clean ways or saving energy. It's a tougher time for startups in enterprise software, networking, healthcare, and life sciences.

That point of view is seconded by Jessica Canning, global research director for the Dow Jones private markets division in San Francisco. "We've seen a nice concentration of startups in the Bay area toward energy and Web 2.0 information providers," such as FaceBook and LinkedIn, she said.

In April, eSolar, a solar power generation firm, attracted $130 million in venture capital; in May BrightSource pulled in another $115 million, including investments from Chevron and Google, for building its planned solar power plants. In June, Rearden Commerce raised $100 million for its mashup approach to aggregating services on the Web for business users. There's no sign, despite the general economic downturn, of the venture capital drying up anytime soon, she said in an interview.

At the same time, she said, the length of time from launch to payoff has been lengthening for startups. It now averages seven years, longer than many venture capitalists would prefer.

Fenwick & West came up with the average 53% increase in value by surveying the 108 companies that did rounds of financing in the second quarter. A startup will typically do a small A round of financing, followed by larger B and C rounds as it gears up to bring a product to market. Fenwick & West compared the assigned stock value of a company in a recent round to its value in the previous round and found the average increase was 53%.

Kramer concedes that it's a number based on stock value assessments by venture capitalist, not marketplace trading in publicly held stock. All the deals, of course, involved companies that are still privately held.

"Liquidity exits are very hard right now," said Kramer. "But we're still getting a fair amount of venture capital investment."

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