Editor’s note: The latest statistics on venture investing are out – and they aren’t pretty as dollars are down and more money is going to later stage funds. Coupled with the woes on Wall Street, VentureBeat Editor Matt Marshall says tough times are ahead for startups.
SILICON VALLEY – When the stock market goes into the dumps, it takes a while for the effects to trickle down to start-ups. That’s because start-ups are often are working away on a project that’s isolated from the larger market — and if they’re lucky, they have money from venture capitalists.
For the start-ups with no angel or VC backing, forget about raising money. They’re going to have trouble immediately. VCs are paying too much attention to their existing companies. But what about those lucky ones — those who already have a venture backer? The conventional wisdom is those companies will have an easier time getting money again when they need it, because VCs want to make sure the companies survive long enough so that they can earn a profit on the investment.
But it comes at a price. When the entrepreneur returns to the VC, an epic battle ensues over valuations. In a climate of fear, the power pendulum swings back to the VCs. The VC knows that an entrepreneur won’t be as likely to get money elsewhere, so he plays hardball. The entrepreneur is more ready to cave in on the valuation. That means when a VC gives the entrepreneur money, the VC can claim more ownership of the company with a given amount of investment (because the company is worth less.) Tension rises, and boardroom fights begin. I saw it all unfold last time, when I started covering venture capital in 2001.
Let’s take a look at the valuations of start-ups during the last boom, and how they trended in subsequent years. The — The Sunnyvale, Calif. company is a developer of chips for the wireless industry. In March, the company closed a third round of funding (Series C) totaling approximately $40 million, alongside U.S. Venture Partners and Foundation Capital. The post-money valuation was $138 million, or exactly in line with the most recent average valuation of late-stage private companies, as provided by the NVCA (see chart). However, as you can see from the last boom-bust, late stage valuations came down significantly. That’s not to say we’re going to see exactly the same scenario play out this time (last time, it was a tech bust, this time it is a credit bust, and companies are generally on much sounder footing). But with the market closed for new IPOs and companies slamming the breaks on acquisitions (they feel poorer, because their lower stock prices are their main currency), there’s no doubt that late-stage companies are going to get seriously slammed on the valuation side if they raise money this year.
– The Minneapolis, Minnesota, company develops implantable devices designed to control hypertension. The company has raised several rounds of financing and New Enterprise Associates has participated in all of them. Other investors in the company include ABS Ventures, Kearny Venture Partners, SightLine Partners, and InterWest Partners. The company raised a third round $30 million in May 2006, at a valuation of $95 million, and then raised $65 million fourth round in April 2007 at a valuation of $267 million, and then a fifth round of $84 million in July year at a valuation of $424M valuation. Needless to say, those recent valuations are extremely high. Who knows, the company may be good enough to justify it. But expect them to come down, especially in light of the general decline in valuations for the health-care sector in general.
(For example, Dow Jones VentureSource reports healthcare valuations dropped from $21.1 million for all of 2007 to $18.04 million in the second quarter of 2008 after a first-quarter bump to $24.75 million. However, in the second and third quarters of 2007 healthcare valuations were even lower at $16.35 and $13.40 million respectively then jumped to $30 million in the fourth quarter.)
– The Mountain View, Calif. company offers on-demand software, and raised a first round of $5.8 million at post-money valuation of $16 million in 2006. Then it raised $3 million more in March 2008, at a post valuation of $24 million. New Enterprise Associates led both rounds financing. As you can see from the charts, the valuations of the earlier rounds didn’t drop as significantly during the last bust. Earlier stage companies will have it slightly easier than later stage private companies. They’re more protected from the market, because they’re not searching for an IPO just yet. However, that’s not to say that investors won’t fight to hard to lower valuations even at this level.
Third quarter statistics on valuations won’t be out for another couple of months. And even then, those stats won’t reflect what happened in the current fourth quarter, which is when the real pain will be felt. It may be next year before we can give a serious assessment of the true fallout for start-ups. Expect to see more companies go out of business too, as VCs in some cases decide not to invest at all.