Dr. Earl R. Smith II

January 25, 2010 @ 12:01am | The KPBJ

The well ran dry last year in Washington as venture capital investments fell 40 percent to $555 million, the lowest amount invested in the state in six years. The number of deals also declined to levels not seen since 2003 as venture capitalists pumped money into just 103 deals.

The declines were also seen nationally, according to the MoneyTree Survey from PricewaterhouseCoopers and the National Venture Capital Association. The report found that investments fell 37 percent when compared to 2008, while the number of deals declined 30 percent.

“The industry is clearly entering a period of contraction,” said Chad Waite, a partner at OVP Venture Partners in Kirkland. “2010 will show better returns than 2009, but in general I think we are returning to an era of more typical returns, rather than the dramatic skew of some of the last few years.”

The sharp declines were to be expected, driven in part by a rotten economy and an unwelcoming market for initial public offerings. But there are some other elements at work here too, causing some in the venture business to reevaluate the industry itself.

Gone are the days when software or Internet entrepreneurs needed $5 million, $10 million or $15 million to get their businesses off the ground. Instead, many technology entrepreneurs these days are foregoing venture capital — or raising smaller rounds — as they race to reach profitability.

That creates a dilemma for some of the larger venture capital funds, which can’t profitably invest their money in early-stage companies that may only require $500,000 or $1 million to get going. That’s what Seattle angel investor Chris DeVore meant earlier this month when he told the Seattle Tech Startups group that there’s “a terminal misalignment of goals and expectations between what a VC fund’s partners are trying to accomplish and what a startup is trying to accomplish.”

Furthermore, the financial crisis pinched many of the large pension funds and university endowments that have long been supporters of venture capital funds.

Without that capital flowing as freely as it once did, venture capitalists are having a hard time raising their own funds. And that too is having an impact on the capital outlays.

“Many VC’s ran out of money over the last two years, and virtually no one raised money,” said Lucinda Stewart, a partner at OVP. “Therefore, the volume will not catch up to 2007 (or) 2008 levels soon.”

In 2007, venture capitalists invested $1.3 billion in Washington State, followed by $961 million in 2008.

Nonetheless, despite the problems facing the industry, several Seattle area venture capitalists say they are still encountering promising opportunities.

“VCs are investing again,” says Stewart. “Most say their pipelines are much larger than last year’s and, most importantly, the bitter cold of the last 12 months has given birth to some pretty tough and focused entrepreneurs. This year could be a flight-to-quality year, which would be good for everyone.”

Bill Bryant, a venture partner at Draper Fisher Jurvetson, agreed. He’s currently evaluating four companies in the region that are working on what could be groundbreaking technologies. “We’re just now starting to see exciting projects, more so than 2009,” he said.

There was another hopeful sign in the numbers. During the second half of 2009, venture capitalists invested $328 million in Washington companies. That compared to $224 million in the first half.

There’s also evidence that VCs once again are supporting early-stage companies. During the first half of the year, only three seed stage deals were completed. For the second half, that number quadrupled to 12.

Washington also remains a center for venture capital investment. The state ranked sixth in number of deals and seventh in dollars invested during the fourth quarter.

Interestingly, the medical devices and equipment category received the most money of any sector in the state, the first time that has occurred since the MoneyTree report started tracking the data in 1995. That category saw $169 million invested. Software, which historically has been the top sector in the state, came in second with $150 million. That was followed by biotech at $58 million and media and entertainment at $50 million.

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