 | |  |
Bucking the trend
By Beth Healy, Globe Staff, 5/12/2003
Without trumpets or fanfare, amid war and a groggy economy, venture capital investing in New England rebounded in the first quarter of the year, even as the money flow declined 10 percent nationally.
Entrepreneurs in this region reaped $692 million in funding, 25 percent more than in the fourth quarter of 2002, marking the first clear increase in activity in three years. Revised fourth-quarter numbers for the Boston Globe MoneyTree survey, compiled by PricewaterhouseCoopers, Venture Economics, and the
National Venture Capital Association, erased the reported decline in the October-to-December quarter and revealed a modest 5 percent increase in deals. That apparent leveling-off, followed by the more vigorous rise in investing in the latest period ended March 31, could indicate that the long post-boom investment slide is over in this region, analysts of the numbers said. "New England as a region is bucking the national trend," said Matthew Littlewood, a partner with PricewaterhouseCoopers in Cambridge. "The question is: What is fueling that increase?"
A few large deals in the still-hot biotechology and life sciences sectors provided momentum during a period that continued, on the face of things, to be tainted by a stubborn malaise. Otherwise, a substantial portion of the money went into later-stage technology companies, suggesting, Littlewood said, that venture capitalists are still regarding young New England companies with great caution.
At Hypnion Inc., a Worcester biotech start-up working on drugs for sleep disorders, which managed to attract $47.5 million in the quarter -- more than any other company in the region -- the fund-raising was grueling, chief executive John Dee said.
"It took us a long time to do it," said Dee, road-weary after 14 months of knocking on doors of venture capitalists in Boston, New York, and San Francisco. "You'd certainly rather be working on the operations of the company than out on the road trying to raise money."
Hypnion is still several months away from clinical trials of its nonaddictive sedatives, Dee said. But the company was able to attract a healthy dose of cash from a long list of backers because of two key assets: a huge target market and a testing system that can predict human reactions to drug compounds with 90 percent accuracy.
"The size of the market is a big deal," said Jean George, a partner at Advanced Technology Ventures, a Waltham venture capital firm that backed Hypnion and was one of the most active firms in New England in the first quarter. As she sees it, 28 million chronic insomniacs in the United States are worth risking a chunk of capital for. But the risk is closely calculated. "ATV has been willing to take clinical risk," George said, "providing that there is a large market opportunity."
Risk is the giant tipping the scales in every negotiation these days between entrepreneurs and VCs. Venture capitalists have been trying to mitigate the risks looming in their portfolios ever since the technology market crashed, and they've hunkered down during this long period in which taking companies public or selling them at a profit has been impossible or disappointing. An undercurrent of conservatism, perhaps inevitable after the storm of the past three years, emerges clearly in the latest MoneyTree report.
The 10 largest deals inked locally in the quarter were reported as expansion- or later-stage. That's a shift from 1999 and 2000, when giant sums of money were being pumped into much younger companies, particularly in telecommunications and e-commerce. Nearly one quarter of the 85 deals inked in New England from January through March were early stage, but those companies received just 10 percent of the dollars invested locally. That's down from a 15.1 percent share in the fourth quarter, and 22.3 percent a year ago. Young companies from the high-tech region in Greater Boston took in $69.4 million in the latest quarter, down from $196 million a year ago.
Half of the top deals were drug developers and medical device makers. Those sectors continued to dominate the region's investing landscape, capturing one-third of all of the money invested. Software claimed a quarter of the dollars invested, and telecommunications inched up from last year's lows, taking 17 percent of the funding.
The apparent piling into later-stage companies is troubling, said Littlewood, the PricewaterhouseCoopers partner, especially since some of the funding is aimed at saving ventures that may not survive. Worse, he said, New England investors seem to be continuing to retrench just as VCs in Silicon Valley and other hot spots are showing new courage in the realm of early-stage companies.
Meanwhile, Silicon Valley start-ups attracted 15.8 percent of the venture capital in their region, up from 15.2 percent in the fourth quarter and a modest 11.4 percent a year ago. New England is lagging the national average, too; across all regions, start-ups reaped 17.3 percent of the total $3.8 billion invested in the quarter.
"They're still being conservative here," Littlewood said. "It's hard to predict whether we have bottomed out, because the numbers you're seeing are largely expansion-stage financings."
Indeed, H and I rounds (equivalent to eighth and ninth rounds) -- letters so deep into the alphabet they have rarely been seen in venture before -- are surfacing in this environment. A whopping 76 percent of the venture money in New England went into expansion rounds in the latest quarter, compared to 56 percent in Silicon Valley.
One local venture firm bucking the late-stage trend is Kodiak Venture Partners, a Waltham firm with a $290 million fund. The firm did four first rounds in the quarter, plus two follow-on rounds for companies already in its portfolio. The activity is consistent; over two funds, Kodiak has gotten into companies at the seed stage or the first official round.
"We want to get involved early like that and get involved in building the company," said Dave Furneaux, Kodiak's managing general partner. Software start-ups are the biggest draw lately, he said. While the economy's not humming, it's a good time to hire talent and fund companies that don't need barrels of money in order to succeed, he said. "Some of the best companies come out of down cycles," Furneaux said. "We think it's a great time to be active."
At Battery Ventures in Wellesley, which is investing a $1 billion fund, the partners are more risk-averse, spreading a good deal of their investing to the later stages. Of the five deals Battery did in the first quarter, one was an A round, according to general partner Tom Crotty.
Not only is it easier to assess a company that's actually selling something, Crotty said, but a company with some experience under its belt stands a greater chance of landing new clients in a nervous marketplace.
"Customers are a little bit afraid of buying from start-ups," Crotty said.
In terms of managing a venture portfolio, loading up on early-stage companies now means hanging on to them, and supporting them with later rounds, for five to seven years. With a weak stock market that's hurting the ability of VCs to exit their investments with profits to return to their investors, many venture capitalists are under pressure to invest in later-stage companies that may produce gains more quickly.
"We're certainly not abandoning A rounds," Crotty said. "It just feels more comfortable to do deals that have customers and revenues."
| | |
