Venture-Capital Activity Focused on Rebuilding in 2004; First Year of Positive Growth in Investing and Liquidity Since the Bubble, According to VentureOne and Ernst & Young LLP

Business Wire, Dec 13, 2004

SAN FRANCISCO & NEW YORK & LONDON -- Venture-capital activity in 2004 is expected to complete the year on a positive note, based on investments recorded through the end of the third quarter by the Venture Capital Report compiled by Ernst & Young LLP and VentureOne, a unit of Dow Jones Newswires.

E[acute accent]This good news was due to the modest return in the liquidity market for venture-backed companies and the subsequent bullishness on the part of investors who regained focus on company-formation investments. World-wide, venture-capital financing has increased 13% so far in 2004, over the comparable period in 2003. In total, $18.99 billion has been invested in 2,369 transactions in the U.S., Europe and Israel. E[acute accent]"The investment downturn that followed the bubble appeared to reach its lowest point last year, marking the end of a venture-capital cycle that began in 1995, the last normal year before the ramp up to the bubble," said Gil Forer, global leader of the Venture Capital Advisory Group at Ernst & Young. "This year was one of rebuilding in the venture-capital industry, as investors world-wide put substantial sums into early-stage investments and increased their fund-raising activities. While we are not anticipating another bubble, it is fair to say that we are at a starting point in a new venture-capital investment cycle." E[acute accent]One of the clearest signs of this starting point is the renewed early-stage investing activity, which represented 32% of the rounds completed so far this year in the U.S., Europe and Israel. Prior to this year, early-stage investing had been on a mostly downward trend since 2000. The median round-size also trended upward in 2004, both for early stage and follow-on rounds. This is related to another trend: the lengthening of the median time between rounds. Investors appear to be requiring portfolio companies to reach significant milestones in their growth and wait nearly twice as long (18 months in the U.S.) for a Series B investment than they did during the bubble. E[acute accent]The reopening of avenues for liquidity also had a role in the year's positive outcome. "The IPO window was virtually shut for the previous three years but 2004 has clearly seen a return for exits as $4.4 billion has been raised by venture-backed companies in the U.S. and European public markets thus far this year. That is the highest amount since the bubble," said John Gabbert, vice president of worldwide research for VentureOne. "On the other hand, mergers and acquisitions activity has remained steady for the past several years, but the bright side is that the amount being paid for these venture-backed companies is steadily improving." E[acute accent]Among those companies achieving liquidity, capital efficiency has proved to be a requirement that has become quite important. A study of the data for recent exits compared the ratio of the total amount invested prior to exit to the sale price, in the case of an M&A, or the pre-money valuation, in the case of an initial public offering. The most successful exit ratios for investors were for those companies that received less investment, and reached liquidity in the shortest time, clearly proving that there is greater reward for those companies able to execute efficiently with limited capital. E[acute accent]IPO exits in 2004 have been dominated by health-care companies, with 39 of the 68 venture-backed IPOs completed so far this year coming from that industry, compared with 21 information technology IPOs. Information technology, meanwhile, has found promising exit opportunities via M&A and represents 64% of these exits in Europe and the U.S. E[acute accent]"The year started with a rally of the public biotech companies, which enabled a number of emerging private companies to break through a limited IPO window. The companies with a mature, well-validated product portfolio, such as Eyetech, Idenix, Pharmion and Theravance, were rewarded with strong IPO valuations which they were able to build on throughout the year despite the macro market turmoil," said Nicholas Simon, general partner with MPM Capital. "However, the majority of the IPOs consisted of less mature companies which the public investors bought at heavy discounts to their proposed IPO price range. Having traded flat to down from their IPO prices, these companies are just recently starting to get the attention of public investors. Their venture investors will need to wait for these investments to mature as public companies before they maximize their returns on them. As for next year, we are seeing a nice post-election and year-end rally among public biotech companies. This bodes well for the prospect of another IPO window during the first half of 2005." E[acute accent]In another positive sign, valuations crept upward for venture-backed companies receiving investments this year in Europe or the U.S. Following the IPO trends, later-stage health-care companies were among the most highly valued companies in the U.S. in the first half of year. By the second half, early-stage biopharmaceutical and software companies saw valuations rise to their highest levels in two years. In Europe, German companies were the most highly valued this year, but valuations were up for U.K. companies as well, compared to last year. E[acute accent]Despite an overhang of capital that remains to be invested since the bubble, venture-capital firms in the U.S. and Israel have had a relatively robust fund raising year so far in 2004. The total amount raised in the U.S., Europe and Israel reached $11.65 billion through the third quarter. E[acute accent]"The downturn in the venture capital market has ended and a new investment cycle is beginning. Capital inflows into venture capital in 2004, though down from the peak of 2000, show a venture capital market that has grown four times in size and importance over the past decade," said Gary Morgenthaler, general partner at Morgenthaler Ventures. "Entrepreneurship is alive and well: major innovations are transforming traditional IT and life science markets, as well as new markets of nanotechnology and alternative energy. Entrepreneurial companies are being formed and financed at near record rates. Despite burdensome new government regulations--including Sarbanes-Oxley, stock options expensing and the separation of research from investment banking--a growing number of venture-financed companies, including Google, have successfully completed their IPOs and are outperforming in the public markets. In summary, the venture capital market ended 2004 back on track and poised for renewed growth through the end of the decade." E[acute accent]Although there has been an improved level of financing this year, European investment activity remains constrained by the transfer of investments into the U.S. E[acute accent]"European investors participated in almost 200 financing rounds in the U.S. through the first three quarters of the year, yet U.S. investors were active in only 142 rounds in Europe, creating a disproportion of international transfers, " said Stephen Harmston, director of international research at VentureOne. "The majority of the European investment into the U.S. came from the United Kingdom and Germany, but on the other side, U.S. investors were much more active in financing U.K. companies, followed by French companies, than investing in German startups." E[acute accent]Beyond Europe, Israel, and the U.S., investors also are considering their Far East investment strategy. The year 2004 may well be remembered as the year of the trip, as increasing numbers of investors ventured to China and India to explore the burgeoning investment opportunities there. The investment level in Asia appears poised to increase significantly in the next few years, beyond the estimated 9% of global investment that it now receives.