Is VC investment plummeting? Yes, but it’s not as bad as it looks

In the wake of a report (pdf) on venture capital activity, a number of industry watchers are pondering the crisis in funding. The press release announcing the report set the tone for the coverage by proclaiming "VC Investment plummets to 12 year low". The New York Times said investment rates have "dropped to lows not seen since before the dot-com bubble".

In the first quarter of this year, VCs invested $3b, which is down by about half what they invested in the previous quarter and down by 61% from Q1 of 2008. That’s pretty scary drop. But it’s hardly a surprise. This trend was apparent the day Sequoia released its now infamous "RIP Good Times" slideshow in October, which struck fear in the hearts of every VC firm. (Did it discourage any entrepreneurs? Probably not, we’re a pathologically optimistic breed.)

It’s also no surprise that money available for early stage deals is disappearing the fastest. Stacey Higginbotham writes: "…it’s looking especially bad for early-stage companies, with only $900 million invested in early-stage deals this quarter, and the rest going to follow-on rounds and later-stage deals. In the last year, almost three-quarters of the total capital has gone into later stage-deals as VCs continue to fund their older portfolio companies while they wait for an exit." I commented on that trend in December.

So where is the good news promised by this post’s headline?

Factor out regional trends…

Fred Wilson, VC and uber-blogger, dove deeper into the numbers and saw some interesting regional trends. Silicon Valley firms ramped up their investment the most in ’06 and ’07 and so their pendulum is swinging further back now. That impact is exaggerating the industry-wide average.  He writes:

What you see is that the total amount raised in Silicon Valley … dropped to an annualized rate of less than $5bn, a 50% reduction. At the same time, the total amount raised in New England… dropped to an annualized rate of below $2bn, a drop of 1/3. And in the NY Metro market, we saw a small decline, but nothing to get excited about…

.. and factor out sector trends…

Aside from the regional trend, there’s a strong sector trend. According to that report, clean tech investments dropped 84% but Internet investment saw only a 31% decline. The key: Internet investments are capital efficient, meaning it takes less money to get a new product to market. That’s what VCs are looking for in difficult times.

Another data point comes from David Shore, head of the Technology group at Research Capital Corporation. He said, if you carve out green tech, biotech and hardware, you see very little decline in both number of deals and amount of money. Here’s a chart drawn from their database of "Web 2.0" investments over the last year:

Certainly you can see a big drop in Oct’08, but it seems like a strong recovery so far for 2009. (Keep in mind that April isn’t done yet, so that last bar on the right is still going to grow.)

… and it’s not so bad.

Going back to Fred Wilson, he concludes: "So while the data doesn’t lie, it also doesn’t tell the full story. There is money out there for good ideas, particularly ones that are capital efficient and located somewhere other than Silicon Valley."