By Tim Mullaney
Oct. 8 (Bloomberg) -- Venture capital investments will probably fall this year for the first time since 2003 as the financial crisis cripples the markets for acquisitions and initial public offerings.
U.S. startup funding may drop in the third quarter, said Tracy Lefteroff, a managing partner at PricewaterhouseCoopers LLP, which does consulting work for venture capital firms. In July, Lefteroff said investments in 2008 would be ``on par'' with the $30.7 billion invested last year.
Turmoil in the credit markets is making it more difficult for young companies to raise money as venture capital firms concentrate on existing investments instead of making new ones. The number of deals closing sank last month, and the aversion to risk is even spreading to clean-energy companies, one of Silicon Valley's hottest sectors since 2006, said Greg Blonder, a partner at Morgenthaler Ventures.
``Everyone I know has had their come-to-Jesus partners meeting,'' said Blonder, referring to sessions where people confront unpleasant truths. ``This will create another hole in the market.''
A locked-up market for IPOs and a 30 percent drop in the average price acquirers pay for venture-backed companies are causing the most pain, said Geoff Yang, a founding partner of Redpoint Ventures in Menlo Park, California.
Lone IPO
Only one startup went public in the past two quarters, as investors shunned commercially unproven technology, according to the National Venture Capital Association and Thomson Reuters Corp. This year marks the driest IPO stretch since 1977. There were 58 acquisitions of venture-backed companies in the third quarter, down from 102 last year, the group says.
Preliminary data supports Blonder's observation that the number of deals fell in September, said PricewaterhouseCoopers spokeswoman Clare Chachere. Third-quarter statistics for venture investing are due to be released Oct. 18.
Clean-energy and chip companies suffer the most from tighter funding because their products are generally expensive to develop, said Blonder, who is based in Summit, New Jersey. That means they could have more trouble raising money, or face more onerous terms.
``The chip industry is both capital intensive as technology companies go, and also cyclical,'' said Arthur Reidel, Chief Executive Officer of Scintera Networks Inc., a Sunnyvale, California-based company that designs wireless chips. ``That's a combination that leads to concern in times that are recessionary and when credit is tight.''
Hoarding Cash
Some startups are preparing for the worst. GreatPoint Energy Inc., a Chicago company developing clean-coal technology, is moving cash into the safest possible short-term investments and running weekly checks on vendors' credit-default swaps, a financial instrument used to gauge whether companies will be able to repay loans.
``We're making sure our spending is disciplined and our counterparties are carefully monitored,'' Chief Financial Officer Dan Goldman said. ``In this environment, you don't know who will be around tomorrow.''
The company may even consider tapping wealth funds controlled by foreign governments for its next funding round, Goldman said.
Others are getting part of their money from the government. Mascoma Corp., a Boston-based startup that needs $250 million to build its first commercial plant to convert wood into ethanol, said yesterday it received $49.5 million in grants from the State of Michigan and the U.S. Energy Department.
Foreign Help
``Next year is key because we are going to have to raise capital, and some of it is going to have to be debt,'' CEO Bruce Jamerson said. ``I'd have to say it's more likely to come from foreign banks. They're not pulling their horns in.''
Some investors say foreign money might be difficult to come by. Foreign funds may be skeptical of U.S. startups that can't raise funding at home, said Promod Haque, managing partner at Norwest Venture Partners in Palo Alto, California.
To stay lean, Haque is urging his companies to outsource some operations to other firms, or use off-the-shelf chips rather than creating their own.
``There's going to be a smaller number of companies left standing,'' said Peter Santos, CEO of Mountain View, California- based Audience Inc., a maker of mobile-phone chips. ``The strong companies that can survive this downturn are going to come out really strong.''
Peter Barris, managing general partner of New Enterprise Associates in Chevy Chase, Maryland, says he urged companies with capital-intensive businesses to raise money before the market tightened. Other investors may have followed that strategy, causing a surge in second-quarter investments in later-stage startups that masked the market's weakness, he said.
``Storing up nuts for the winter is a good phrase for it,'' Barris said. ``Nobody knew it would get like this.''
To contact the reporter on this story: Tim Mullaney in New York at tmullaney1@bloomberg.net
Last Updated: October 8, 2008 00:01 EDT
