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Abreast of Venture Investing
By Steve Kam, Keiretsu Forum Member
In this first of a two part series, I will discuss current pricing indications and trends in venture investing during the third quarter of 2003. The second installment of this series to come in April will discuss actual pricing by industry sector, stage of development, and round of funding during the fourth quarter of last year.
Where The Money Went
Since the third quarter of 2002, the VC community has invested around $4 billion per quarter in new and existing portfolio companies. In the aggregate, $4.2 billion was invested in 667 companies during the third quarter of 2003. Recent buzz that venture capital firms have grown more receptive to brand new start-up companies seeking initial capital is exaggerated based on the most recent data gathered by National Venture Capital Association, PriceWaterhouseCoopers, and Thomson Financial’s Venture Economics showing that the percent of first-time financings during the third quarter was relatively unchanged compared to the first half of 2003. First round financing totaling $766 million, 18% of all investment, went to 148 companies, aggregating to 22% of all companies that received VC money during the third quarter. Clearly VCs continue to favor later rounds and stages of development with 72% of all dollars being placed with more mature opportunities.
Industries receiving first-time dollars were as follows: 38 software companies, $138 million; 16 biotechnology companies, $72 million; 15 medical device companies, $54 million. Telecommunication (7) and networking (6) companies were in last place and continued to be the segments out of favor within the institutional community. In total the biotech industry was the number one recipient at $873 million. That’s an increase of 31% over the second quarter of 2003 and 88% from the same period in the prior year (Q3 ’02). The broader life sciences sector (biotech plus medical devices & equipment) received $1.24 billion or 30% of all dollars invested in Q3’03. Judging from third quarter activity, VCs are bullish (again) on the profits from expected services and products that are contemplated on today’s research and development. Now 30% is a disproportionate share of attention and investment that augurs for a significantly high number of failures for this sector (again), while good opportunities in other industries will be ignored, go begging, or shout of being relatively underpriced.
Overall Pricing Indications And Market Read
First round valuations declined to a median of $4.25 million in the third quarter, about equal to where they had been in the first quarter of '03. The later round median increased to $19.5 million. Profitable companies achieved the highest valuations of the quarter with a median of $22 million. The valuation increases in later stage and profitable companies reflects the overall investor expectation that many venture-backed companies will have a liquidity event in 2004. The expectation for near-term liquidity raises market value. Those expecting liquidity, but not getting it, and who paid more for it, could be doubly disappointed: (1) continued illiquidity and (2) a decline in the value of their round or flattening of pricing for the next private round as they await the chance to exit.
According to VentureOne, venture-backed healthcare companies continued to generate the highest median valuations at $20 million; exceeding the valuations for information technology and products and services companies. Healthcare valuations in Q2,’03 averaged $15.8 million. A median valuation of second round funding for healthcare companies was $38.6 million, the highest of any industry group by round. Biopharmaceutical companies averaged a whooping $41.4 million valuation.
Median valuations for IT companies increased to $8.4 million from $8 million in the second quarter ’03. Electronics and computer hardware companies valuations were the primary leaders. Semiconductor and communications companies’ valuations declined in the third quarter. Software companies were flat. Products and services companies rose sharply to $15.6 million, the highest in three years. However the increase in this sector’s valuations was driven disproportionately by the financings of a few mature companies that had achieved profitability, underscoring the VC’s investment bias for proven success.
Third quarter money went to expansion situations and later stage rounds. Profitability was most desired and the demand and expectation for near-term liquidity drove valuation increases. The exception to this pattern was the renewed belief in the life sciences promise. Nothing new in all of this, except the emergence of the VC from his self-impose hibernation following the late 20th/early 21st centuries investment binge.
Next newsletter we will summarize pricing by industry, stage and round for all of 2003 and valuation indications for 2004 based on the fourth quarter. Also, what’s hot (and pricing that reflects exuberance), what’s not, and why an angel investor should care.
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