PwC MoneyTree VC Survey Q4 2004 Summary

VC investment in the US increased 15% in Q4’04 to $5.3 Billion, vs the prior quarter, and was down 2% vs Q4’03. The past 11 quarters have all been between $4.3-6.0 Billion, so we appear to have reached a predictable level of investment in the $4-6 Billion per quarter range for the foreseeable future.

VC investment for the full year 2004 totaled $20.9 Billion, an 11% increase over 2003. This was the first year since 1994 we have not had at least a 15% change up or down, so don’t bet on stability quite yet. To put these fluctuations into perspective, virtually every year from 1983 to 1991 changed less than 15% from the prior year and almost every year after 1991 has fluctuated more than 15% from the prior year, so Bob Dylan was right…the times, they are a changin’.

The US continues to dominate the global venture capital market for technology companies. Global technology vc investments totals by country:

Silicon Valley remained the #1 area for investment in Q3’04, getting 32% of the US dollars. The other top 5 markets receiving funds were:
   2. New England: 16%
   3. Southeast: 8%
   4. Wash DC: 7%
   5. (tie) LA/Orange County: 6%
       San Diego: 6%
       Texas: 6%

California received roughly 45% of the venture capital investments in the US, which should bode well for the California economy, no matter who the governor is. Southern California (LA/Orange County/San Diego) appears poised to rival New England for #2 area of investment in the near future.

Software remained the #1 category with $5.1 Billion invested. The other top 5 sectors in Q4’04 were:
   2. Biotechnology: $3.8 B
   3. Telecommunications: $1.9 B
   4. Medical Devices: $1.8 B
   5. (tie) Semiconductors: $1.6 B.
       Networking & Equipment

Later stage investment still commands a high percent of the vc total, with roughly 30 % of vc dollars going to Series E or later. Investment by round for Q4’04 was:
   Series A: $ 1.1 Billion
   Series B: 0.9
   Series C: 0.9
   Series D: 1.1
   Series E+: 1.6

Series A appears to have stabilized at roughly 20% of the dollars invested. Series A remains below the total of Series E+, which indicates a large number of companies are being kept afloat and that returns to venture capital will remain poor by historical standards, and that the equilibrium level of investment is below 2004’s $21 Billion.

Median deal size has remained between $4-5 Million for 16 consecutive quarters, indicating the companies that can raise money can raise substantial amounts.

Average pre money valuations started to rise in 2004, as follows

*All valuation numbers are a rolling 12-month average

Top Private Equity firms as defined as # of deals were:

	Q4’04	all 2004
1. Kleiner Perkins	21	73	1. NEA
2. Oak	16	61	2. Draper Fisher Jurvetson
3. Mobius	15	52	3. Intel
4. NEA	15	49	4. Polaris
5. (tie)  Intel/MPM/InterWest	14	49	5. USVP

Venture firms appear to have settled into two camps:

1. Veteran Firms on at least their 4th fund. Little fear of raising a new fund. GP’s are generally senior ex-operating execs. These firms are generally quite aggressive, making significant number of investments in 2003 and 2004 and plan to continue doing so in 2005.

2. New funds, less than 4 funds under their belt. Significant fear of raising a new fund, GP’s often have little or no operating experience. These funds are generally quite cautious at making new Series A investments, focusing on keeping their existing companies alive that appear to have a chance at a decent exit, hoping one of them can save the fund and allow them to raise another fund. They are also often bidding up valuations on later stage financings of top tier funds’ deals, again hoping to get a quick, lucrative exit and save the fund, the vc equivalent of a “hail mary pass”.

LP’s appear conflicted over continued investment in vc funds. The 20 year IRR for all vc’s has dropped to 15.8%, barely above NASDAQ’s 12.1% or S&P’s 12.4% over the same 20 years. Additionally, most of the returns in the venture industry are in the top quartile of funds. Consequently, even though many LP’s want to invest heavily in the venture industry, they are not able to get into the top funds and are hesitant to invest in firms that have not demonstrated consistent returns above NASDAQ. Ironically, this has produced more interest in first time funds, particularly if the GP’s have a good investment history individually.

This concern over returns will likely shrink the vc industry over the next few years from its current run rate of $18-20B annual investment. A number of analysts now speculate the “equilibrium” rate of investment is $10-12B annually, roughly the level of investment in 1996.

Please visit www.pwcmoneytree.com for full report on the PwC MoneyTree VC Survey.