VC deals off 8.5% in first quarter as credit crunch, economy take a toll on exits

Venture capital transaction volume dropped about 8.5% in the first quarter over the fourth quarter of 2007, according to data released over the weekend by the MoneyTree Report from PricewaterhouseCoopers LLP, New York, and the National Venture Capital Association, Washington.

Another survey by Dow Jones VentureSource, San Francisco, pegged the deal flow decline at 7%, which the company said was the lowest level since the first quarter of 2005.

Although transaction volume generally is slow in the first quarter, the economic environment and the credit crunch have made it difficult for venture capital firms to exit their investments by taking their companies public or selling them.

Venture capital firms invested $7.1 billion in 922 deals in the first quarter vs. $7.8 billion in 1,045 deals in the fourth quarter of 2007, the MoneyTree survey revealed. Venture capital firms’ investment in the first quarter of 2008 was down 5% compared to the first quarter 2007, according to MoneyTree data. Dow Jones reported similar numbers, with venture capital firms investing $6.8 billion in the first quarter of this year, compared to $7.35 billion in the first quarter of 2007 and $7.5 billion in the fourth quarter of 2007.

Commenting on the drop, Nina Saberi, managing general partner of Castile Ventures, a Waltham, Mass., venture capital firm, said the slow pace of initial public offerings and acquisitions also will affect the speed of new investments by venture capital firms.

However, transactions are cyclical, and generally the pace of venture capital-backed deals picks up in the second and fourth quarters, noted John S. Taylor, vice president of research of the National Venture Capital Association.

James E. Thomas, partner at venture capital firm Thomas, McNerney Partners, Stamford, Conn., said venture capital firms will be owning portfolio companies longer, causing them to invest more money while awaiting exits.

The slow-exit environment is causing institutional investors to lose patience with the venture capital asset class, said Monte Brem, chief executive officer at StepStone Group LLC, a private equity consulting firm in La Jolla, Calif. One problem is that few venture capital firms have been able to show realized gains in the last four years, Mr. Brem said.

This has resulted in lower allocations to venture capital, he said. Instead, institutional investors have been shifting to midmarket private equity, international private equity, mezzanine and distressed debtinvestments, Mr. Brem said.

“They are shifting to other strategies and not plain-vanilla buyout and venture capital,” he said.

A few sectors such as health care and life sciences are showing some promising returns, Mr. Brem said.

Venture capital firms are continuing to invest in the life sciences sector, which includes biotechnology and medical devices, according to the MoneyTree report. Still investment in the sector was flat in the last two quarters. Venture capital firms invested $2.3 billion in 220 deals in the first quarter, about the same amount that was invested in the fourth quarter of 2007.

Mr. Taylor said early-stage venture capital investments are not as affected by the slowdown because new companies won’t need exit strategies for another five or six years, when the business environment is bound to pick up, Mr. Taylor said.

Even so, seed and early-stage investing fell 17% in the first quarter of 2008 to $1.7 billion in 330 deals, according to the MoneyTree survey.

Contact Arleen Jacobius at [email protected]