Venture bulks up(2)

New research on the venture capital market provides some grounds for optimism, as an increase in typical deal size takes investment levels to a four-year high despite fewer deals taking place.

European venture capital investment hit €4.12 billion ($5.34 billion) in 2006, its highest level since 2002, according to new research.

The data, published by VentureSource, a joint venture between Ernst & Young and Dow Jones Venture One, shows that investment levels were 5 percent up on the equivalent figure for 2005, fuelled to a large extent by the steadily recovering technology sector.

The figures suggest that venture firms are making bigger bets on a smaller number of companies.

Despite the increased level of investment, dealflow was down significantly for the year as a whole with just 867 deals completed – a 27% fall from the previous year. This pattern was particularly evident in the fourth quarter of the year – just 193 deals were completed, compared to 329 for the same period in 2005, but investment levels remained constant at just over €1.0 billion.

This was also reflected in the increase in the median deal size, which reached €2.2 million – its highest level since 1999. Technology and healthcare were two sectors where this trend was apparent. The median technology deal topped €2 million in every quarter last year, while the median healthcare deal hit €2.8 million – an all-time high.

However, the data seems to dispel the notion that this focus on fewer, bigger deals is having a detrimental effect on seed and early stage investing. In fact, more early stage deals took place than last year – 40% of all deals completed in the year were for early stage investments, compared to 32% in 2005, and the total figure of €1.26 billion was the highest for this end of the market since 2001.

Nick Powell of Ernst & Young’s UK Venture Capital team said 2006 had been notable for deals at both ends of the venture spectrum: “After supporting existing portfolio companies toward eventual exits, venture capital investors are moving to fund the next wave of innovation”.

Gil Forer

Energy, Web 2.0 and consumer and business services were some of the most popular segments, Powell said. “Fortunately, investors also are getting these companies off the ground with significant sums, perhaps recognizing that the time to reach an eventual exit is growing longer.”

The recovery of the information technology sector seems to be continuing. Investment in this sector totalled €2.12 billion in 2006 – over half of the total for venture as a whole and its highest level since 2002. Again, dealflow was generally down across the various parts of the sector but the average deal size was generally up. One of the largest deals of the year was am €83.2 million later stage investment in Plastic Logic, a UK-based semiconductor firm.

One other sector enjoyed significant growth: energy, which saw dealflow increase by 17 percent and total investment by 14 percent.

The healthcare sector saw some notable early stage deals, but in general performance was disappointing, with 31% fewer deals and a 13 percent drop in investment levels.

However, on the whole most of the key European geographies had better news to report, with the UK, France, Germany, Netherlands, Belgium and Spain all seeing an increase in investment levels.

There is still bad news for European VCs however, as fundraising continues to be sluggish on the continent. The third quarter of 2006 saw just half as much capital raised as the same quarter in 2005, with just five funds raising €451.7 million. A slowdown in fundraising has occurred throughout the spectrum, with European buyout firms also seeing a decline.

“It’s no secret that a lot of VCs in Europe are unable to raise their next fund,” says Gil Forer, global director of Ernst & Young’s venture capital advisory group. “I don’t see it as a major problem though. There were a lot of very small players in the market that shouldn’t necessarily be in the market. For me it’s not an alarming signal, the fund that need to raise money were able to.”