Surprise! VC Funding Fell Off a Cliff in Q4

As expected, the venture industry is seeing the fallout from the economic crisis, with fourth-quarter investments dropping to a total of $5.4 billion invested in 818 companies, according to a report from PricewaterhouseCoopers and the National Venture Capital Association based on data provided by Thomson Reuters. That’s a 33 percent plunge from the $8.09 billion invested in 1,051 companies in the fourth quarter of 2007.

With the exception of a few industries, these fourth-quarter numbers show a sharp pullback by VCs between the third and fourth quarters of 2008. Indeed, VCs are nursing their growing portfolios of later-stage companies that are unable to exit through a public sale or an initial public offering — and waiting for the economic fallout to subside.

As we reported after the third-quarter NVCA conference call, valuations are down for venture-backed companies seeking additional rounds of financing. With exit markets essentially closed, there remains a cluster of later-stage deals cluttering up venture portfolios. Pascal Levensohn, of Levensohn Venture Partners, notes that this is an expecially good time to get a better deal on later-stage companies willing to settle for early-stage valuations. “Capitalization models are out of sync with the reality of the market,” he says.

The MoneyTree data also tries to look on the bright side, noting, for example, that in all of 2008, VCs made the most seed-stage investments since 2000. They put $1.5 billion into 440 companies, compared to $1.3 billion into 450 companies during 2007. However, those seed investments fell along with all the other investments during the last three months of the year, with $199 million going into 62 startups — a 47 percent drop in dollar terms and a 43 percent slide in terms of companies over the fourth quarter of 2007. And the fourth-quarter dive caused 2008 to be the first since 2003 that venture capital investing has declined on an annual basis.

With venture firms pondering their investment strategies, so far startups in the media and entertainment business and cleantech are still seeing a slight increase in deals, making it appear that venture firms are pulling back most strongly from the software, semiconductor and Internet technology sectors.