A Look at Liquidity: Venture Funding Hits 12-Year Low Amid Cold IPO Market

[Editor's Note: In this first installment of a two-part look at whether the credit crisis continues to crimp financing for companies and consumers, Money Morning looks at the venture capital market. In Part II later this week, we'll study bank lending trends.]

By Mike Caggeso
Associate Editor
Money Morning

Capital venture firms in the Unites States invested only $3 billion in 549 deals in the first quarter - a 61% decline from the first quarter last year - hitting a low that dates back to before the dot-com bubble.

Investment activity was down 47% from the $5.7 billion invested in 866 deals in the fourth quarter last year, according to research by the non-profit National Venture Capital Association (NVCA) and PricewaterhouseCoopers LLP.

"Given the economic turmoil that began in the third quarter of 2008 and continued on into 2009, it's not unexpected that the (venture capitalists) would pause to assess the impact on their portfolio companies before again looking forward to their next investment," Tracy Lefteroff, global managing partner of the venture capital practice at PricewaterhouseCoopers, said in a news release.

Declines plagued nearly every sector - both in the total amount invested and the number of deals.

Software companies received the highest level of funding, with $614 million invested in 138 deals. But that was still a 42% drop in dollars invested and a 34% drop in total deals compared with the fourth quarter of 2008.

Clean-technology (alternative energy, pollution and recycling, power supplies and conversion) was the hardest hit sector, as investment fell 84% to $154 million in 33 deals from a record high of $971 million in 67 deals in the fourth quarter last year.

The financial services sector was the only one that saw an increase in dollars and deals - taking in $108 million from 17 deals, increases of 26% and 21%, respectively.

In addition to having considerably less money to invest, venture capital investors were also weary of investing in new companies and technologies that couldn't promise a short-term return.

Instead, they spent their money on companies and sectors they already own, John Taylor, vice president of research at National Venture Capital Association, told Bloomberg.

"We are in a very difficult, stressed time," Taylor said. "Everyone is trying to figure out what is going on."

The investment drought in clean-tech could bottleneck the sector, as ready-for-market technologies can't get out of the lab.

"We are continuing to see a lot of innovation coming out of universities and government labs, but the big challenge looming is how any of these will be scaled and who will pay for them to see the light of commercial day," Noubar Afeyan, chief executive of Flagship Ventures, told The New York Times.

Mark Heesen, president of the NVCA, wasn't entirely pessimistic over the figures. Venture firms with the ability to invest are pulling the trigger on capital-starved entrepreneurs with "game-changing" technologies, he said.

"While this drop in investment is significant, we are not forecasting levels to continue to fall further," Heesen said. "We would expect a mild and steady increase in investment throughout the rest of the year, particularly if the exit pipeline is allowed to clear."

Two recent deals gave hope to the static initial public offering (IPO) market.

Shares of language instruction software titan Rosetta Stone Inc. (RST) rose about 40% on its first day of trading, netting the company $112.5 million. And online college Bridgepoint Education, Inc. (BPI) rose 7% on its opening day of trading, reeling in $141.75 million from its initial stock sale.

Both companies' shares continued making gains for the rest of the week after their IPOs.

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