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November 29, 2000

Shaking The MoneyTree , Q3/2000:

Shaking The Money Tree, Q3/2000

First Down Quarter For VC Investments Since The Net First Headed Up

(Reston, VA -- November 29, 2000)  “What I see is a need for patience,” said Jim Palumbo of PricewaterhouseCoopers (PwC), “ and I see a lot of people on the investing side actually having some patience.  That's good for both in the short term and the intermediate term.

Palumbo was speaking at "Shaking The Money Tree," a quarterly event sponsored by PwC and the Morino Institute's, examining the regional results of PwC's latest MoneyTree™ survey of VC investments. Commentary and analysis were provided by three leading venture capitalists: Jack Biddle of Novak Biddle Venture Partners, Rich Harris of SpaceVest and Suzanne King of New Enterprise Associates (NEA).

Palumbo’s comments were a reaction to numbers showing that VC investments have shrunk in Q3 regionally and nationally. Internet entrepreneurs had been getting spoiled over the last two years with constantly higher reports of venture investments in startup companies.  What goes up must come down, however, and anything as consistently hot as the sector had to cool eventually. As Biddle noted, “One hundred percent internal rates of return have been the norm for most of us the last few years, but for that rate of return to be sustained, last year's crop of startups would have to produce the entire gross national product in a decade.  You could see that something had to give, and it snapped.”


PwC’s Eric Ayres presented some of the highlights (and lowlights) from the numbers, including:

  • Nationally, just over $17 billion was invested in roughly 1,200 companies, down 11% from Q2.

  • Locally, $877 million was invested in Q3, a drop of 30% from just over $1 billion dollars invested in Q2. According to Ayres, that’s not as bad as was predicted given the lack of big investments in the troubled telecom sector that is so prominent in the region.  Q3 actually marked the lowest level of telecom investments since Q1/1999.

  • Regionally, because of the absence of big telecom deals, as well as pressure on valuations, average deal size for this quarter dropped to just over $10 million from $15.3 million in the second quarter.  Nationally, deal size was virtually flat at about $10 million.

  • Health care services was a bright spot for the region, with Q3 marking the largest amount of money going into this sector since the survey started six years ago.

  • Lastly, software continues to dominate in the region, with software companies raising approximately $400 million during Q3, a 60% increase over last quarter and a 200% increase over Q3/1999.

  • Among Internet-related investments in the region, a category that cross all sectors, the “Tools & Applications” sub-group boomed during Q3, but B2B and B2C continued their predicted decline. Here are the breakdowns:

Internet-related Sector Q3/2000 (millions)  Q2/2000 


Access/ Infrastructure   $121.3 $196.0  -38.1
Services $156.2 $194.0 -19.5
Tools/Applications $259.3 $185.0  40.2
B2B eCommerce  $35.3 $118.0 -70.0
B2C eCommerce  $43.0 $54.0 -20.4
Content Sites $68.1  $38.0  79.2

Why the down turn? “It's a pretty easy question,” said King.  “The [public stock] market is down, so our exit opportunities are down.  I'll give you an example.  Last year, NEA had 22 companies go public and 48 sold.  From that standpoint, we had more capacity to take on new companies.  When the window slammed shut, as it has this year, we don't have as many companies going out of our portfolio, so our inventory of companies has built up and the capacity to take on new deals has shrunk.”  Last quarter, NEA was the second most active investor in the region, but nearly all of their regional investments were follow-ons to companies they had invested in previously.

Biddle added, “A lot of these companies are just not going to make it, so we are all scrambling, trying to make sure that our companies are the ones that get funded, which takes a lot of time.” It’s not just a bandwidth problem, he said VCs also have to raise their investment threshold because it's harder to make money and limited partners have become used to higher rates of returns.


  “You don't make your money in the venture business with your home runs,” he said, “You make your money by getting your bait back on your bad deals and making a little bit of money, or a medium amount of money, on your good deals.  That's the way the business really works.  In the last few years it made no sense to worry about your bad deals because you made so much on a home run like Sycamore or Juniper.  With what's happening in the industry now, your bad deals are actually going to determine whether you are a top quartile or bottom quartile fund.”

Here’s the good news, before the rest of the bad news, anyway¾good deals will still get done.  Investors are being much more selective and patient, and some companies that might have gotten funding a year ago won’t get it today, but VCs are in the investing business and they still have a lot money to invest with.  What’s it going to take for entrepreneurs to get that money?  Less pie-in-the-sky revenue projections and more solid business fundamentals: a great management team, a revenue model that's working, a focused strategy and, ideally, customers who love your solution.’s Fran Witzel calls it “a return to sanity.”

The rest of the bad news is that things won’t turn around over night. “It will take a couple of years to come back, said Biddle, who noted that, “The numbers you see in the MoneyTree actually lag reality by about a quarter because, when we make a commitment to do a deal, it takes six or eight weeks to do the documents and make our commitment.  The deals that have already been agreed to in the third quarter will close in the fourth quarter, so the drop will be quite significant.  I would speculate that the fourth quarter will probably see more than a 50% drop in venture investment.”

Harris added, “I think we are seeing something of a flight to quality.  People are certainly instilling a little more discipline in their investment criteria.  They are less likely to look at something as a momentum play and more likely to concentrate on value investing, which I think is what venture capital has always really been about.”

There’s still good news, however, and always an upside.  Both investing and entrepreneurship are all about upside.  “Yes, it's a down quarter, but it's still the second highest quarter ever,”  said Harris, and he added, “I think that we are going to see a continued slowdown with probably less money invested, maybe fewer deals going next quarter, but I think it's going to continue to be cyclical.  I think it's going to be a down trend for a while, but the public markets will come back some day.  They always do, and, when they do, I think you'll see VC investments increase.”

That’s what has always happened before in hyper-hot markets¾several times in biotech, and most dramatically, in the PC craze of the 1980s.  We are in the same kind of environment, according to Biddle, “A lot of money was made.  Capital chases returns until it becomes over-invested in the space and we see the shakeout.”  But, as he went on to say, don’t forget that, “There were a lot of companies that were founded in the late 1980s that got to be huge corporations, so the business goes on.”

Despite the slowdown, Biddle and the others offered encouragement, “There is a lot of venture capital out there and there are a lot of great ideas.  A lot of companies will get funded, and you are going to see some major corporations grow from basements. There is still a ton of opportunity for entrepreneurs and investors.”

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