Seed, Early Stage Investments Regaining Favor Among Venture Capitalists

Some $1.49 billion was invested in early stage deals in the third quarter -– the most this year and 13 percent higher than one year ago, according to Dow Jones VentureOne. Of the more than $6 billion invested in the quarter, 38 percent went to seed- and first-round deals.

PricewaterhouseCoopers and the National Venture Capital Association reported similar numbers in their quarterly MoneyTree totals. PWC and NVCA said early and seed-stage deals topped $1.2 billion, up 10 percent.

The trend reflects “greater confidence in young companies overall,” according to PWC’s Jeff Barber, who is based in Raleigh.

Those statistics certainly caught the attention of Jim Verdonik, who works with numerous early stage companies through the Daniels, Daniels & Verdonik law firm in Research Triangle Park.

“I’m not sure this is a tipping point where the pendulum starts to swing back again in favor of early stage deals, but it’s something people have been watching for,” Verdonik told WRAL Local Tech Wire.

Investors -– from venture firms to angels -– have been a bit squeamish about getting into early deals in the wake of the 2001 “dot com” bumble. Fundraising has fattened venture fund coffers, however, and a rising stock market has helped angels recover from the “dot com” crash and recession to the extent that plenty of money is available, Verdonik said. And there are too few later-stage deals to absorb the money -– or later-stage deals may not produce the kinds of returns investors want, he added.

“It was inevitable,” Verdonik said of the early stage swing. “When everyone rushes to the more mature side of the market like all the v.c.’s and the angels have done, that has a depressing effect on returns.”

The venture fund “overhang” -– money that has yet to be invested -– was more than $50 billion entering 2006, based on some estimates. Fundraising has already pulled in more than $25 billion through three quarters of 2006 compared with $27 billion in all of 2005. Through Sept. 30, however, less than $20 billion had been invested this year.

In fact, so much money has come into the system while exits such as initial public offerings have remained rare that Silicon Valley heavyweight venture firm Sevin Rosen announced earlier this money it was returning some money to investors.

Steve Nelson, managing partner of The Wakefield Group, isn’t convinced the pendulum has swung away from later-stage deals. However, he also likes what he is seeing in terms of “deal flow” from promising startups.

“I don’t know that there is a trend developing,” he said, “but clearly there are quality early stage deals. I know that there are really high-quality deals in the works as we speak.”

Nelson, who was co-chair of the Council for Entrepreneurial Development’s recent Tech 2006 conference, said he was pleased by the quality of the 27 early stage firms picked to present at that event. However, he also cautioned that with more investment money available, the deal opportunities will be limited by the quality of entrepreneurs seeking to build new firms.

“There still is a finite number of great people available,” Nelson explained, “and when they do become available, they get snatched up pretty quick.”

Nelson’s preference continues to be looking for good people “who have done this before” rather than good ideas without a strong team behind it.

“Good ideas only become great ideas when you have great people behind him,” he said.

Third-quarter investments hit $6.36 billion in 611 deals, according to the Venture One Dow Jones report.

PWC and NVCA reported similar numbers, including $1.5 billion going to what they described as “first-time financing” investments. That category includes some mature companies that are already producing revenue and are accepting venture financing for the first time.

However, Barber wasn’t ready to say early stage deals were suddenly going to dominate deals. He noted that many “living dead” companies that escaped being “purged” by venture firms in the post-2001 shakeout have gotten funding through fifth, sixth, even seventh rounds. Now, many of them are either exiting through IPOs or mergers and acquisitions.

“The dollars going into some of those later-stage deals were among the largest,” Barber said.

VentureOne noted that the third quarter produced three straight quarters of investments topping $6 billion for the first time since 2001.

In the Research Triangle, VentureOne and Dow Jones reported 16 deals worth $99.40 million. Three other deals across the state and South Carolina produced another $29.50 million.

In Georgia, 40 deals worth $139.45 million were made.

PWC and NVCA reported 15 deals across North Carolina totaling $116 million. The totals were down slightly from the second quarter, when 19 deals worth $150.5 million were made. In the first quarter, 19 deals totaling $119 million were made.

The state continues to be on track to have its best venture year since 2002, when $553 million was invested in 84 deals.