U.S. companies find venture capital harder to find

October 24, 2012

U.S. companies that rely on venture capital investment to expand their businesses and hire employees have struggled to raise money this year, new data show.

The trend came to light in a pair of recent quarterly venture capital reports that used different data to arrive at the same conclusion: Investors aren’t pouring as much money into young companies as they were this time last year.

The impending presidential election is likely weighing on some investors, industry insiders say, particularly because the outcome of the race could lead to higher tax rates on these types of investments.

Analysts are quick to caution that a single quarter does not make a trend. That’s true. But investments are down for the first nine months of the year overall, making it unlikely that 2012 will post end-of-year results that are the same as or better than 2011.

The recession brought venture capital investments to their lowest point in a decade as investors hit the breaks on new deals, using their money instead to keep existing businesses afloat.

Although the past two years have seen the venture industry gradually regain its footing, figures still hover well below pre-recession levels. And if the latest reports are any indication, a complete recovery may be a distant goal.

U.S. firms collected $6.9 billion in 820 venture capital deals during the third quarter of the year, a 32 percent drop in dollar value and 9 percent decline in number of deals compared with the same period last year, according to a Dow Jones VentureSource report released last week.

The year-to-date numbers are less drastic. Dow Jones VentureSource tallied $22.8 billion raised by U.S. companies in 2,525 deals thus far into 2012, a 15 percent decline in dollars and 3 percent slide in deals compared with the first nine months of 2011.

A venture capital roundup from PricewaterhouseCoopers and the National Venture Capital Association also released last week found similar trends.

Although it may be a more challenging environment for some companies to secure investments, the most promising ventures can still find the capital they need.

“Things will turn around in this industry. It’s a question of when,” said Tracy Lefteroff, global managing partner of the venture capital practice at PricewaterhouseCoopers.

“The strong companies do survive in this environment, they do get funded, and at some point down the road we’ll see this trend turn around . . . and we will see returns come back,” Lefteroff said.

Analysts and investors point to a confluence of factors dragging the numbers down, including the uncertainty surrounding the presidential election, now less than two weeks away.

President Obama and his Republican challenger, Mitt Romney, have presented different, if sometimes hard to define, tax plans that could result in wealthy Americans and investors paying new tax rates on income and capital gains.

What’s more, the threat of the George W. Bush-era tax cuts hitting their January expiration date without renewal creates added uncertainty for investors who would have to pay higher taxes when they cash out of their investments.

Lefteroff said that paying a lower tax rate on capital gains is one of the reasons wealthy individuals and organizations are inclined to invest their money through venture capital firms. Without that incentive, the deals lose some of their appeal.

For Peter Barris, managing general partner for New Enterprise Associates, however, that uncertainty has little influence over day-to-day investment decisions.

“The fact of the matter is, it’s very hard to figure out exactly what policies either the Obama administration or a potential Romney administration would have that impact us,” Barris said. “Whether people in our industry get taxed on carried interest or don’t get taxed on carried interest will matter to the future of our business.”

More pressing for many venture capitalists is the struggle to raise money from their financiers, known as limited partners, who make it possible for them to cut checks.

Many of those financial backers have opted for less risky investments or put larger chunks of money into fewer venture capital firms. The result is less money to go around.

“The number of funds in the business is shrinking, and when those funds basically go out of business or invest in the last deal that they have money for . . . that takes one source of capital away from new deals and new dollars,” Lefteroff said.

But not all venture capital firms are wanting for funds.

Chevy Chase-based New Enterprise Associates announced in July that it had raised $2.6 billion from its limited partners. Barris said many venture houses continued to invest even as their coffers were running dry, forcing them to slow the pace of their investments in recent months.

“There clearly has been less capital coming into the industry and what was happening, if you looked a year ago, was the pace of investing wasn’t slowing down, despite [the fact] that capital inflows were,” Barris said. “That’s a trend that’s not sustainable.”

The lack of funds is compounded by the public markets, which have not been as hospitable to initial public offerings as investors would like. Investors rely on those exits to recoup their investment in one firm and then pile it into another.

The economic downturn made it nearly impossible for companies to pursue a public offering at a price that allowed investors to turn a profit. Even firms such as Facebook and Groupon, which saw banner IPOs, have watched their valuations tumble after the fact.

“What do you think happens to the appetite of those buyers the next time an IPO comes along? It doesn’t help the venture business when those things happen,” Lefteroff said.

Steven Overly covers the business of technology, biotechnology and venture capital in the Washington region for The Washington Post and its weekly Capital Business publication. In that capacity, he has written about start-up struggles, investment trends and major drug discoveries.
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