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Abreast of Venture Investing
By Steve Kam kam@houlihan.com, Keiretsu Forum Northern California Member
In this second installment of the series of two articles, I will discuss where the money went in 2003, in particular in the 4th quarter, and what that activity and the demonstrated industry preferences may foretell for early stage investing during 2004.
2003 vs. 2002
Let us establish what we do not need a table to tell us, and then see if the data is helpful for looking ahead. Pricing was down for all industry sectors except software, especially from first round investors. The impact on angel investors: your pricing largess should have declined as well to reflect overall risk aversion, reduced near term liquidity, and higher required rates of return by institutional investors. With the exception of a slight up tick in pre-money valuations in software, the table below provides a broad outline of more conservative investing across all other industries. Internet and telecom companies lead the valuation death spiral followed by semiconductor price declines. Including software’s 6.4% pricing increase, the average (non-weighted) change was a stunning minus 27.7%. Even the ever-hopeful biotech sector suffered a 12% beating in median financing valuations.
Median Pre-Money Valuations, Venture Related Deals
First Round
| Indices | Median Value 2002 | Median Value 2003 | Percent Change |
| Telecom | 8.00 | 3.80 | -52.5% |
| Software | 4.70 | 5.00 | 6.4% |
| Internet | 7.50 | 2.42 | -67.7% |
| Network | 3.00 | 2.50 | -16.7% |
| Computer Hardware | 4.95 | 4.31 | -12.9% |
| Biotech | 7.52 | 6.59 | -12.4% |
| Pharmaceuticals | 6.63 | 5.2 | -21.6% |
| Finance | na | na | na |
| Semiconductor | 6.07 | 3.38 | -44.3% |
Source: Venture Economics
Indications from the Information Technology Sector
Quarter by quarter pre-money valuation data was not available at the deadline for this piece, except on the information technology sector which did report a sufficient number of financings to provide one meaningful insight. First round pre-money valuations for the 4th quarter was up compared to the prior four quarters: $5.3 million (4th quarter ’03); $3.0 million (3rd quarter ’03); $4.5 million (2nd quarter ’03); $4.0 million (1st quarter ’03). Said differently, median pre-money valuations for the 4th quarter were 75% higher than the 3rd quarter, 16.7% higher than the 2nd quarter, and 31.3% higher than the 1st quarter. But there should be no surprise that median pre-money valuations in the 4th quarter of ’02 at $7.6 million was over 43% higher than the 4th quarter ’03. The take away information on this one sector is that while pricing is down 30% Q4 to Q4, the pricing trend is up decisively and could return to the pre-hibernation (absence of institutional investing) levels of 2002 during 2004. Angel money should beware of such a rapid valuation rise and the images of a hot sector. I think we saw this popular delusion recently with devastating results for all stakeholders.
The median first round, pre-money valuations for all sectors combined from the 4th quarter 2002 through the 4th quarter 2003 (in millions for the five most recent quarters for which data is available) were $4.60, $4.51, $4.75, $4.16, and $5.50, respectively. That 19.6% increase is a benchmark to watch right now. You should demand an abundance of reasons before you pay more than the undifferentiated industry valuation appreciation rate for the company you are considering in 2004. Since we are coming off of a significant economic correction accompanied by venture company pricing restarts, the near term valuations do not owe anyone anything. That is, we should not anticipate first round prices returning to any particular level recently reached by venture capital investors. Rather, those would be the investment opportunities to avoid in 2004.
The Popularity Story Told by the VentureOne Data
The industry sector groups that experienced the greatest increases in venture money investment for all funding rounds between 4th quarter ’02 and 4th quarter ’03 were Biopharmaceuticals (59% increase) and Medical Instruments (56% increase). The groups with the greatest decreases in investment were Information Services (-32%) and Communications (-30%). The median amount invested by round decreased most for Healthcare (-64%) and Medical Information Services (-27%), and increased most for Consumer & Business Products (+145%) and Electronics & Computer Hardware (+45%). Finally, median pre-money valuations by industry sector for all funding rounds during this same period increased most for Information Services (+57%) and Software (+49%) and decreased most for Medical Devices (-41%) and Medical Information Systems (38%).
The observations are many from 2003 and the industry sector money movements and the general valuation trends should influence defining what is attractive for 2004 investing. Angels should factor these recent valuation runups and newly created candidates for sector darlings into their analysis that examines which companies, products, and management teams are going to create the five, ten, or 20 fold increases in their investment dollars. Expectations reflected through median measurements of investor sentiment may be the single most important factor in an Angel’s decision in 2004.
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