Venture Investment Near 13-Year Lows, Even After Q2 Uptick

Investments by venture capital firms rebounded last quarter, reversing five quarters of declines, but remain near 13-year lows.

Venture capitalists invested $3.7 billion in the second quarter, up 15% from the first, while the number of deals overall was about even at 612, according to the MoneyTree report set to be released Tuesday.

For the first time since the National Venture Capital Association and others started tracking these data in 1980, biotech surpassed software as the largest single category of venture investment. Investment in life sciences, including biotech, jumped 47% to $1.5 billion. But information technology, including software, stayed just ahead of life sciences, with $1.7 billion invested, according to the quarterly MoneyTree report compiled by the NVCA, PricewaterhouseCoopers and Thomson Reuters.

"Life sciences is one of the few sectors that still has a steady stream of exits," Tracy Lefteroff, managing partner of the venture capital practice of PricewaterhouseCoopers, said, referring to ways VCs can cash out on investments. "We've seen some big mergers and acquisitions in the biotech and medical devices space."

Venture capital investment has been falling since the first quarter of 2008, as the U.S. and global economies weakened and the market for initial public offerings began to lag. The rebound last quarter came in a period when five VC-backed companies made IPOs, the highest number of VC-backed IPOs since the first quarter of 2008.

In a conference call with the media to discuss the latest MoneyTree report, venture capitalists said the rebound, while welcome, doesn't necessarily indicate that good times have returned.

"We keep hoping the IPO market will come back, because that is the best endgame," said Ray Rothrock, a partner at Venrock Ventures, which has some $2 billion under management.

Venture firms in general prefer to make money in investments via IPOs, which can bring the biggest returns.

"We desperately need the IPO market to come back, but I'm not seeing it happen just yet," said David Jones, chairman and managing partner of Chrysalis Ventures, which manages some $400 million.

The lack of IPOs, mergers and acquisitions is forcing venture capital firms to spend historically large amounts of time and money on older companies.

"The industry is still very much focused on later-stage deals," said John Taylor, vice president of research for the NVCA.

Later-stage deals, typically investments in companies that have been in portfolios for at least seven years, accounted for 34% of the 612 investment deals in the second quarter, the third-highest level ever, Taylor says. First-time and early-stage funding accounted for 38% of investments in the quarter, well below traditional levels near 50%.

As venture capital firms have cut back on investments, corporations have stepped in to an extent, according to Dow Jones VentureSource, which also tracks VC investing.

Its separate quarterly report, released Saturday, said corporations accounted for two of the 10 largest funding deals in the quarter. One was a $50 million investment in Tesla Motors by German giant Daimler, which got a 10% stake in the electric car developer. The biggest deal in the quarter was a $200 million investment in Facebook by Russia's Digital Sky Technologies, for a 1.96% stake. (MoneyTree excludes corporate funding in its report.)

Like MoneyTree, Dow Jones VentureSource also showed strong investments in life sciences.

Bryan Pearce, leader of the venture capital advisory group at Ernst & Young, which helps prepare the report, says IT is not less attractive to VCs. Rather, he says such startups need less funding. He cites more use of lower-cost open-source software and lower labor costs in the recession.

"There are a lot of talented programmers available in the marketplace at lower cost than a few years ago," Pearce said. "You can build these companies cheaper."

In the MoneyTree survey, biotech led. Such companies garnered $888 million in 85 funding deals last quarter, up 54% from the first quarter. Software companies received the second-highest amount, with $644 million, while Internet companies received $524 million, down 15%.