CSPA VC Outlook for 2007: Looking down the Money Trail

CSPA held its first event for 2007 at the offices of Wilson Sonsini at 950 Page Mill Road in Palo Alto on January 17th. It was a VC panel titled VC Outlook for 2007: Looking down the Money Trail. It was apparently so popular that it was oversubscribed. I was one of the lucky ones who happened to make it well and early to the event in addition to preregistering. The CSPA usually does an excellent job of its events, the last one I attended in 2006 being an evening with the legendary Vint Cerf, who can legitimately claim to be one of the inventors of the Internet. This event was no exception. The panel was moderated by Steve Bengston of Price Waterehouse Coopers with John Steuart of Claremont Creek Ventures, Eric Dunn of Cardinal Venture Capital, Gus Tai of Trinity Ventures, Pete Moran of DCM Doll Capital management and Tom Rosch of Interwest Partners as panelists.

To me, the most interesting part was Steve Bengston’s presentation on the MoneyTree Report – Update for Q3 2006. The MoneyTree Report is jointly produced by Price Waterhouse Coopers and the National Venture Capital Association and is in its 12th year, and as such can be expected to be based on fairly reliable data. The presentation focused mostly on US venture capital, with some interesting comparisons to the ROW (Rest of the World). 2006 looked to be on track to show total investments of about $25B, with roughly $6B a quarter for the first three quarters. This would make it the best year since 2001 ($40.5B) and higher than 1998($20.7B). Its almost as if the boom years are here again. Of the Q3 2006 investments (~$6.242B), 32% or ~$2B (250 deals) was invested in Silicon Valley and nearly 50% of the total was invested in California if you add the San Diego, LA and Sacramento areas. What was more interesting was the comment that Silicon Valley's share of VC money has not gone down over the years. Of course, in comparison for most of the ‘80s and till 1995 the total annual investment was only around $3B. 2000 of course, the year of the big boom showed total investments of $104.4 B. So, even after the tech bust of 2000, the showing of ~$19B till Q3 for 2006 indicates faith in technology and Silicon Valley to generate the next big thing.

The bulk of the money went into Series E or later rounds. Median deal size was $5M. Biotech accounted for $1.14B (95 deals), with software following at $1.095B(186 deals) and telecommunications at $848.3M (72 deals). Clean technology (industrial/energy) accounted for 9.2% of the Q3 2006 deals tripling in two quarter from about 3%. So, probably the perception that clean technology may be the next big thing from Silicon Valley may indeed have some credibility. Surely, my friends at the Gunther Portfolio can take heart from this trend. However, today's coverage of the Clean Tech Summit in Palm Desert, CA by CNET points out that despite the influx of VC money and strong demand for solar technology, hurdles remain to widespread deployment.

The top three most prolific VC firms for Q3 ’06 in terms of investment were Intel Capital, New Enterprise Associates and Draper Fisher and Jurvetson. In terms of exits, the IPO market was weaker in 2006 than in 2004 or 2005. However, 2007 is expected to be a hot year for IPOs, with several high quality companies waiting in the wings. SOX compliance was ensuring the quality of the companies.

The VC panel gave their opinions on what they looked for in funding startups. Areas of interest ranged from internet search, click fraud, RFID, casual gaming, internet advertising, intersection of IT with healthcare, pharmaceutical, biotech, medical software, digital media, software as a service, powersaving technologies and ultrawideband wireless etc. In the panel’s opinion its as easy (or difficult) to get funding as ever. Though some of the VCs suggested that it may be possible to get funding with a brilliant idea on a whiteboard, others stressed the need for an unfair advantage, a strong team who has done it before, market or customer traction and a strong business plan. A rule of thumb was that 1 in 200 (0.5%) deals get funded. So, even in times of plentiful venture capital, VC investments are fairly selective.

The panel felt that private equity firms which also provided capital, operated in a different space than VC firms and sometimes even provided exits for VC funded companies. Web 2.0 companies tended to be weak on technology and customer acquisition was important and difficult. Purely digital semiconductor companies were increasingly rarely funded. Analog and mixed signal semiconductor companies are being selectively funded. Biotech investments tended to be longer term due to regulatory issues. Medical device investments offered the opportunity for absolute monopoly.

On advice to entrepreneurs, the panel recommended keeping the rounds of financing to a minimum (preferably three), allowing 18 to 24 months between financings. In general, one could expect 15 to 45% dilution in each round. Company structure could be a mix with people in Silicon Valley and overseas, with the key ideas and customer relationships being driven from the valley, while execution could be based elsewhere. Some of the VC firms with investments in China and Japan were seeing liquidity of their investments.

As with the opinions of the WCA VC panel, the VC sentiment appears more upbeat than in previous years. What was startling was the comparison of US VC investments of $19B for the first three quarters of 2006 compared to $1.2B for China and $0.4B for India. Of course, the same money buys a lot more in India and China, but, the comparison highlights the advantage that Silicon Valley companies have in terms of capital access. Of course, there's always some place else in the world which says they are the new Silicon Valley. Surely, imitation is the sincerest form of flattery :-)