Venture Capital Investment Quickens, But Still Down From '08


Led by a strong rebound in health care, U.S. venture capital investment recovered from its first-quarter low, but still remains well off last year's pace.

In the first half of 2009, 1,078 U.S. venture-backed companies raised $9.28 billion, according to VentureSource, a research unit of VentureWire publisher Dow Jones & Co. This was 44% less than the $16.47 billion raised by 1,459 companies in the first half of 2008, before the financial crisis reached full tilt.

In the second quarter, 595 companies raised $4.87 billion compared with 483 companies raising $4 billion in the first period, which marked an 11-year low. But second-quarter performance was nowhere near last year's when 726 companies garnered $8.33 billion.

Venture investment in U.S. health care companies shot up 62% last quarter from the first quarter, and was only slightly below the year-ago clip, as VCs jumped on opportunities to back promising companies at low valuations. In fact, the dollar amount invested in health care, $2.23 billion, surpassed the $1.89 billion recorded in the traditionally largest sector, information technology, for the first time in a quarter this decade.

IT investment, especially software, continued to be slow with deal totals only slightly above the first three months of the year. Investors in fact put less into software deals in the second quarter than in the first -- $696 million versus $715 million. Overall IT investment rose 8.5% quarter-to-quarter but fell 41% below last year's total.

Data also show that venture investors are being frugal. The median first round investment in the second quarter fell to $3 million, the lowest since at least 2003.

"There's a natural shrinking of the business and that's going to ripple through everything," said Dave Furneaux, a managing partner at Kodiak Venture Partners. He said investment might pick up in the second half, "but I'm hoping that the levels of investment are coming down because there's less people investing and there's less money on average going into rounds.

"There's only so much innovation you can fund, and I think we've learned in the last decade that we were trying to fund too much innovation and that leads to a lack it," Furneaux said.

Others were cheered by an uptick in early rounds. First rounds rose from 125 in the first quarter to 167 in the second quarter, although this was significantly below the 255 in last year's second period. "I would hope that does show we've kind of bottomed out in investing and things are starting to pick up there," said Bryan Pearce, who leads the national VC advisory team at accounting firm Ernst & Young LLP.

On the health care front, investment surged across the board, with big gains occurring in biopharmaceuticals, medical devices, health care services and medical software and information services.

The rebound was expected, some investors said, since the first-quarter totals were low. The $1.38 billion invested in the first three months was the least since the second quarter of 2003, when $1.34 billion was invested. In the wake of the September crash, firms reassessed their portfolios to be sure they had reserved enough for their projected winners. With that analysis largely complete, they're getting back to investing, some said.

"It's return-to-business type numbers," said Lou Bock, managing director of Scale Venture Partners. In late 2008 and early this year, many companies still sought valuations that they could have gotten before the collapse, but not now, he said. By the second quarter, most had lowered their expectations, which helped more financings get done. "It takes some time for that seasoning to happen," Bock said.

With firms now ready to invest, and many companies looking for money, VCs said they expect health care investment to remain steady or increase in the second half of 2009. Despite the slowing economy, a few health care firms have closed large funds in the past year, including Essex Woodlands Health Ventures, which announced the closing of its eighth fund at $900 million in March, and Aisling Capital, which wrapped up its current fund at $650 million in December.

Some investors also see reason for optimism in the M&A transactions that have occurred recently, especially in medical devices. Medtronic Inc. this year has paid over $1 billion for venture-backed CoreValve Inc. and Ventor Technologies Ltd., for example.

"There's a sense that valuations have fallen significantly and there are signs of the economy stabilizing," said Rodney Altman, senior partner of CMEA Capital. "There are also signs that the larger companies are being more acquisitive. I think people feel more optimistic that exits will appear on the horizon."

Firms invested $766 million, in 79 medical device financing rounds, last quarter, up 41% from the $545 million deployed over 43 financings in the first quarter.

Meanwhile, biopharmaceutical investing climbed 72% to $1.22 billion last quarter from $709 million in the first quarter. Despite the slumping economy, investors last quarter showed some willingness to place large bets on new biopharmaceutical companies. In May, for example, Clovis Oncology Inc. closed a $146 million tranched financing to assemble a portfolio of cancer drugs.

With Congress looking to extend health insurance coverage to millions of people who are now uninsured, there will be a growing demand for companies that can administer health care services more efficiently, some investors said. Last quarter, 14 health care services companies raised a total of $145 million, compared with $60 million invested in five financing rounds in the first quarter. Meantime, medical software companies raised $90 million through 19 rounds in the second quarter, up from $63 million in 15 rounds in the first quarter.

One big believer in health care services and health care-IT is Psilos Group Managers, which has backed companies such as Click4Care Inc., a provider of end-to-end medical management software systems to help coordinate a patient's care. "We think that unique service models work," said Albert S. Waxman, senior managing member. "You've got to be able to lower costs and improve quality."

While the trends point up, investors remain concerned about financing risk, and are wary of making new investments unless they're confident that the existing syndicate can carry a company until it's ready to be acquired, or go public. As a result, some investors are still holding back, said Stephen Reeders, managing partner or MVM Life Science Partners. "People are concerned [that] even some good companies will run into difficulties for lack of funds," he said.

Renewable energy reversed its first-quarter decline, perhaps, like health care, benefiting from action in Washington. Investors put $221 million into 16 deals versus $156 million into 10 deals in the initial three months of 2009. But the pace is way down from last year when $897 million went into 30 deals in the second quarter alone.

"The fog is lifting a little bit on where the government is in the stimulus package," said E&Y's Pearce.

New Enterprise Associates was the top investor in the second quarter with 16 deals, followed by Canaan Partners and Kleiner Perkins Caufield & Byers with 12 each.

(VentureSource has provided charts for this data at: