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How much venture-capital funding still sits on the sidelines?

By Tricia Duryee
Seattle Times Eastside business reporter

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It's been estimated that there is $55 billion waiting on the sidelines in the United States, and yet only $64.5 million was raised by 10 companies in Washington during the quarter, according to the Ernst & Young, VentureOne U.S. Venture Capital Survey coming out today.

This could be considered a dramatic dry spell compared with the record-breaking downpour experienced at the peak of the boom, that being the first quarter of 2000, when 73 companies raised almost $1 billion. During that time, some companies single-handedly raised as much money as the total amount raised in all of last quarter.

And even when compared with more recent times, the drop is still significant. In the same period a year ago, $150.5 million was raised by 17 companies. In comparison, last quarter saw a 57 percent drop in capital raised.

The numbers don't seem to add up. With an estimated $55 billion dollars waiting to be spent, how come there aren't more bets being placed? Some doubt $55 billion is an accurate figure, while others say it's not the right time in the Seattle area's business life cycle to be investing.

The industry calls the estimate of free investment capital "the overhang," which is commonly derived by surveying VCs.

John Gabbert, vice president of worldwide research at VentureOne, said it is a moving target. Already it has dropped by $35 billion in the last nine months, not from investing, he said, but because some venture funds have returned money to their investors. Instead of being pressured to make timely investments, funds were pared to make them more manageable.

The reverse is true, as well. Some funds have gotten smaller because their investors have refused to fulfill commitments.

The figure also doesn't take into account how much of the money is being set aside for prior investments, making it even less representative of how much free capital there is.

Venture capitalists have had to put aside a significant amount of money for prior investments because they don't know how long it will take for the companies to be acquired or have an initial public offering — the two ways VCs get their money back.

"There's not $55 billion sitting out there," said Gerry Langeler, partner at OVP Venture Partners in Portland. "I think there's been a bunch of erosion, and it's not easily trackable."

Langeler said that if the estimate is accurate, he would question how much money is elsewhere versus in the Northwest.

"Are we running out of money in the Northwest that's fresh? I don't think so," he said.

However, he wonders if that could be a concern in the upcoming year.

To determine how much money is still available is a difficult task. Typically, venture capitalists won't say. But it is increasingly clear that a majority of funds in the Pacific Northwest are getting close to the end of their life cycles.

Funds usually are invested in the first four to five years after they've been raised. At that point, the partners spend the rest of the typical 10-year partnership reinvesting in the companies they've already made. Sometimes, if they can, they raise another fund to make new investments, or conceivably go out of business.

In Washington, of the 20 funds VentureOne has on record, 13 were listed as having raised their last money in 1999 or 2000. That makes most of them in their third or fourth year — close to the end of the period in which they make new investments.

"This could be the leading edge of that, where we get down to fewer venture funds that have fresh cash," said Langeler, whose firm has raised its sixth fund more recently.

Seattle has also seen some funds, based elsewhere, leave town, peeling back the onion a bit more. Mohr Davidow and Atlas Venture, which had offices in Seattle during the boom, have closed in the last year.

Tony Audino, managing partner at Voyager Capital in Seattle, said the Northwest isn't going dry.

"Certainly we've had some funds leave town," he said. "But the ones who are here, are here to stay and have capital to invest. We have $100 million. ... There's no shortage of capital."

Instead, Audino said the numbers are down because technology is shifting. New infrastructure is being built, and once that's completed, it will be Seattle's turn again to write and develop much of the software — our sweet spot. Until then, it may be reasonable that there won't be as much venture investing.

He said it's not only because there aren't new ideas being generated, but also because the companies that have survived until now are either well-funded or self-sufficient.

The turnaround could be on the horizon, Audino said. "We are at or nearing a low point," he said.

Nationwide, signs of a rebound are already starting to appear. Venture investing has been flat for about a year. In the third quarter 2003, just under $4 billion was invested, nearly as much as the prior quarter and down only a bit from the year-ago period when $4.6 billion was invested in venture-backed companies.

Also, there is more activity in the two sectors that venture capitalists like to see most — initial public offerings (IPOs) and mergers and acquisitions.

Compared with just two venture-backed IPOs in the first half of the year, six were completed in the third quarter, raising $429 million. Mergers and acquisitions are up slightly, with 74 startups being acquired, compared with 71 in the prior quarter.

More important, perhaps, is that for the past two consecutive quarters, venture capitalists have been making money on the companies that have been sold.

In the third quarter, the median price for an acquisition was $26.7 million. The median amount of money raised by companies being acquired was $18.2 million.

In prior quarters, VCs were losing money on the companies that were being acquired, or were only close to breaking even. (That's not counting deals in which only a company's assets have been sold.)

"It does matter that (mergers and acquisitions) are picking up," said Greg Gottesman, a managing partner at Madrona Venture Group in Seattle. "That encourages people not only to invest, but entrepreneurs to start new businesses."

Tricia Duryee: 206-464-3283 or tduryee@seattletimes.com

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