Q2 2006 venture capital investing reaches highest level since 2002

Quarterly strength driven by biotech dollars and seed/early stage deals

In the second quarter of 2006, venture capitalists invested the highest dollar amount into the most deals since Q1 2002, according to the MoneyTree Report by PricewaterhouseCoopers and the National Venture Capital Association based on data by Thomson Financial. During the quarter, venture investing grew to $6.3 billion in 856 deals, representing a 2% increase in dollars and a 5% increase in deals from the prior quarter. The increase was driven by strength in the Biotechnology, Industrial/Energy, and Networking & Equipment sectors, all showing solid gains in the quarter. Seed/Early stage deals and Expansion stage dollars both showed solid growth from Q1 2006. And, first-time financings reached a five-year high.

Mark Heesen, president of the National Venture Capital Association, said, "It appears as if the venture capital industry is slowly ratcheting up investment levels for the first time in four years, and these increases seem to be directed in a prudent manner. We are encouraged by the upswing in the number of seed and early stage deals--these companies represent the future of our industry. But equally as important is the diversity of the investment dollars into multiple industry sectors. Rather than pouring money into a lot of "'me-too"' deals, venture capitalists are finding unique opportunities in emerging industries that allow the industry to scale up responsibly."

Sector and industry analysis

Driven by an extremely robust quarter for Biotech investing, the Life Sciences sector (Biotechnology and Medical Devices industries, together) increased 10% to $1.8 billion in 185 deals over Q1 2006. In the second quarter, the Biotech sector received 34% more dollars than in Q1 and experienced the highest number of deals in report history at 112. The increase in Biotech investing was offset by a decrease in funding for Medical Device companies, which fell by 22% in Q2 to $549 million but remained well within the investment range of the last 12 months.

"This quarter's record-breaking number of biotech companies receiving funding makes it abundantly clear that venture capitalists recognize the long-term viability of the industry," said Tracy Lefteroff, global managing partner of the venture capital practice at PricewaterhouseCoopers. "Based on the fact that funding for startup biotech companies more than tripled from Q1 in this already hot industry, we have the potential for some interesting growth in the sector in the coming year. And, given the current pace of overall investing, 2006 looks to set a five-year high."

Software investment dollars declined in Q2 with $1.3 billion going into 231 deals but remained the largest single industry category with 20% of total dollars and 27% of all deals.

The Industrial/Energy sector showed a 62% dollar increase, with $417 million going into 46 companies, reaching a five-year high. The majority of this increase can be attributed to Alternative Energy deals, which increased 69% in dollars over the prior quarter and nearly quadrupled in terms of deals. Networking and Equipment also experienced a very strong quarter, increasing 45% over Q1 in terms of dollars and 60% in deals.

Internet-Specific companies captured $916 million going into 143 deals in Q2, remaining relatively flat from Q1 and accounting for 14% of total investment. "'Internet-Specific"' is a discrete classification assigned to a company whose business model is fundamentally dependent on the Internet, regardless of the company"'s primary industry category such as Software or Telecommunications.

The Telecommunications industry category, experiencing a drop in investing in Q1, remained flat this quarter. Investments in the Wireless sector continued to decline in terms of dollars but increased slightly in terms of deals, rising 17%. Other major industry categories that experienced increases in investment amounts in Q2 were Electronics/ Instrumentation and Semiconductors, both which have been climbing steadily over the last year, rising 17% and 15%, respectively from Q1 2006.

Stage of development and 12-month average valuations

Venture capital investment in Startup and Early Stage companies remained flat from the prior quarter in terms of dollars but increased 13% in the number of deals to $1 billion going into 268 deals, suggesting that VCs are offering smaller rounds to more companies. Average post-money valuations of Early Stage companies dipped slightly to $14.06 million for the 12 months ending Q1 2006. (Note: Valuation data lags investment data by one quarter.)

Funding for Expansion stage companies hit the highest investment level in four years, reaching $2.9 billion, a 17% increase over the prior quarter. The number of deals rose slightly to 329, a 6% increase from Q1. The average post-money valuation for Expansion Stage companies increased to $59.16 million for the 12 months ending Q1 2006 compared to $56.81 million in the Q4 2005 period.

Investments in Later Stage companies declined by 11% from Q1 with 259 companies capturing $2.4 billion. However, average post-money valuations continued to increase to $96.41 million for the 12-month period ending Q1 2006 from $94.72 million ending Q4 2005. This increase is likely reflective of the maturity of the companies still in the pipeline due to a sluggish IPO market.

Overall for Q2, Startup/Early Stage companies accounted for 31% of the deals; Expansion Stage, for 38%; and Later Stage for 30%. These percentages showed Startup/Early companies snatching percentage points from the Later stage companies.

In summary

Overall, the level of Venture Capital Investing has remained relatively stable, hovering in the $5 to $6.5 billion range each quarter for the past 18 months. This shows that solid business plans with real growth potential have plenty of opportunity to obtain funding, yet VCs still remain prudent in distributing capital to entrepreneurs.

The above article is based on results from the MoneyTree Report by PricewaterhouseCoopers and the National Venture Capital Association, based on data provided by Thomson Financial. The report is a quarterly measure of cash-for-equity investments by the professional venture capital community in private, emerging companies in the U.S.