Short on Institutional Investors, Venture Capital Firms Fund Fewer Start-Ups

(July 22, 2011) – Venture capital firms provided a total of $8 billion of funding to start-up companies during the second quarter of 2011, marking a 5% decrease from the second quarter of 2010, Dow Jones VentureSource has reported. 

The number of funding deals made between start-ups and venture capital firms also decreased by 2% between the two quarters. The healthcare sector experienced the greatest losses, with capital investments down 17% from Q2 2010, and deals down 12% from Q2 2010. The lone bright spot in the healthcare sector was in medical IT, where 19 deals worth $158 million amounted to a 27% increase in capital invested and a 58% increase in deals.

The success of IT companies was not limited to healthcare-specific firms. Overall, IT companies experienced a 9% increase in capital and a 5% increase in deals relative to 2010. Software companies – especially those targeting business applications and communication – accounted for more than half of the deal volume in the IT sector with 184 deals worth $1.2 billion.

Between the first and second quarters of 2011, deals and capital investments both increased by 19%, according to a press release  from the American Venture Capital Association (NVCA). A source at VentureSource told aiCIO that it is dangerous to put too much stock into these increases, however, because of seasonal trends in venture capital.

One of the reasons that venture capital firms have invested less in start-ups is because institutional investors are hesitant to invest in venture capital firms in the wake of the financial crisis, according to the NVCA. Traditionally, institutional investors – such as pension funds and endowments – invest in venture capital firms, who in turn fund start up companies. Without the backing of institutional investors, it is difficult for venture capital firms to maintain their investments in start-up companies.

According to Mark Heesen, the president of the NVCA, “For the past three years, the venture capital industry has been investing significantly more dollars into companies than it has been raising from institutional investors. This level of investment cannot continue if we do not start to see a pick-up in exits and, subsequently, fundraising.”

The stagnation of US venture capital has contributed to a steady narrowing of the once-considerable gap in performance between US and UK venture capital firms, aiCIO reported in June. The report focuses on a study entitled “Atlantic Drift: Venture Capital Performance in the UK and the US,” which concludes that the worsening performance of US funds – not an improvement in UK fund performance – is the reason for the narrowing gap.

By Justin Mundt