New data shows that VC investments are getting larger, but there are fewer of them.
There are two ways to spot a venture capital bubble when looking at quarterly investment data:
- Find a noticeable increase in prices being paid for deals. Unfortunately, that's kind of a red herring -- because no data provider has a large enough set of valuations figures to be significant.
- Find a noticeable increase in deal sizes across most stages of company development. This one we can do.
Venture capitalists invested $5.87 billion in 736 U.S.-based companies during the first quarter of 2011, according to a new MoneyTree Report released by PricewaterhouseCoopers, the National Venture Capital Association and Thomson Reuters. That works out to $7.98 million per deal, which is 18% larger than the average deal size during the prior quarter. It also is 21.6% higher than the average deal size in Q1 2010, and a whopping 47% larger than the average deal size in Q1 2009.
Moreover, the average early-stage, expansion-stage and later-stage deal was larger in Q1 2011 than was the comparable deal in 2010. That's important, because it indicates that this isn't just reflective of VCs putting more of their eggs into less-risky, later-stage deals (which tend to be larger, just by virtue of more mature companies requiring more capital).
The only "stage" to record a drop in average deal size was "seed," although I wouldn't read too much into that. Not because seed isn't important, but because MoneyTree does a lousy job tracking such investments -- largely because it excludes individual angel investments, which make up a large slice of the seed market.
To be clear, none of this means that VC returns from Q1 2011 deals are going to be lousy. Just like high or low deal volume isn't necessarily reflective of a healthy or sick market.
But the rising deal sizes do indicate that VCs are trying to pump more and more cash into companies than they were in recent years past. And that means they expect larger cash-on-cash returns. Some of this extra money could be due to rising company costs -- Silicon Valley engineers are going for a mint -- but some also could be born of increased valuations. Yes, I know I just wrote that we don't actually know average valuations, but VC firms typically like to hold a certain ownership percentage. Assuming that percentage stays static, then rising deal sizes indicate rising prices.
The only counter to this argument is that the Q1 deal-count was the lowest since Q3 2009. If it was a bubble, the hypothetical goes, then wouldn't VCs be throwing cash at more companies rather than fewer?
Yes, in theory. But the reality is that many VC firms have had extraordinary difficulties in raising new funds over the past few years, which means new portfolio companies are at a premium -- and are becoming more concentrated in a smaller number of funds. This isn't like 1999, when dozens of new VC funds were being formed monthly. The bubble, as it were, remains more the province of general partners than limited partners.
Overall, software companies continued to lead all industry sectors with $1.1 billion raised for 187 companies last quarter. This was followed by industrial/energy with $1.03 billion for 75 companies and biotech with $784 million for 85 companies.
The quarter's largest deal was a $201 million round for BrightSource Energy, an Oakland, Calif.-based thermal power plant developer, that raised $201 million. The rest of the top five was Plastic Logic ($200 million), Fisker Automotive ($111 million), Tabula ($108 million) and SoloPower ($78 million).
Per usual, Silicon Valley led the nation with $2.49 billion invested in 212 companies. New England placed second with $639 million for 90 companies, and New York Metro snared $580 million for 69 companies.
Finally, kudos to MoneyTree for finally making some needed changes to its methodology. First, it has begun counting corporate venture capital investments. Second, it has begun counting funding rounds that come after acquisition financing (previously, an acquisition financing would invalidate all future VC rounds). MoneyTree has made these changes retroactively to its historical numbers, which may put it more in line with rival data provider Dow Jones.
Update: Some of you have suggested that I should have looked at median deal sizes instead of average deal sizes. Unfortunately, such data is unavailable from MoneyTree. An alternate data provider, CB Insights, however reports that the rising VC deal size trend does still hold when looking at medians: