Intuitively, most people realize that the financial crisis has not been good for the people who start high growth companies financed by venture capitalists. But they may not realize how badly the financial crisis has affected these entrepreneurs’ efforts to raise money.
Dramatic Drop in the Number of Companies Financed
The financial crisis caused venture capitalists to cut back dramatically on the number of companies they finance. According to data from Price Waterhouse Coopers Money Tree Report, the number of venture capital deals dropped 40 percent from the second quarter of 2008 to the first quarter of 2009 (see figure below). While investors have since increased the number of deals they made, this figure was at only 85 percent of pre-recession levels in Q2 of 2010.
Number of Venture Capital Deals from Q1 2007 through Q1 2010:
Source: Created from data from Price Waterhouse Coopers Money Tree.
The decline in investments has fallen most heavily on entrepreneurs seeking venture capital for the first time. According to the National Venture Capital Association (NVCA), the number of companies getting initial financing fell 44 percent from 2007 to 2009, while the number of venture capital-backed companies declined by 28 percent.
Venture Capital Investments Fell in Dollar Terms
Venture capitalists cut back on the amount of money they invested in young companies during the recession. As the figure below shows, from the fourth quarter of 2007 to the end of the first quarter of 2009, venture capital dollars invested in young companies dropped by a whopping 58 percent. While the amount invested has since recovered somewhat, at the end of the second quarter of 2010, the figure was only 85 percent of pre-recession levels.
Dollar Value of Venture Capital Investment Q1 2007 through Q1 2010 (thousands):
Source: Created from data from Price Waterhouse Coopers Money Tree Report.
The Value of Investment Rounds Declined
Venture capitalists also reduced the amount of money they were willing to provide their portfolio companies. According to data from the NVCA, the average dollar value of an initial financing in 2009 was only $3.32 million, 43 percent of the 2007 level. The average dollar value of a follow on financing in 2009 was $14.4 million, only 62 percent of the 2007 level.
The financial crisis led to a big increase in the number of venture capital-backed companies experiencing a down round – a round of investment in which the company has less value than in the previous round. According to data from the law firm Cooley, LLP, which tracks the share of venture capital investment deals on which it provided legal work, the share of companies experiencing an up round plummeted 78 percent between the third quarter of 2008 and the first quarter of 2009, and is currently at only 77 percent of the pre-recession level (see figure below).
Percentage of Up Rounds from Q1 2007 through Q1 2010:
Source: Created from Data Provided by the Cooley Venture Capital Report, Various Issues.
This data points to several conclusions about the impact of the financial crisis on entrepreneurs’ efforts to raise venture capital:
1. Few problems emerged until after the financial crisis began in the summer of 2008. The recession itself, which began six months earlier, did not have a large effect on entrepreneurs’ efforts to raise venture capital.
2. The downtrend followed patterns in the stock market, with big declines in the second half of 2008 and a low reached in the first quarter of 2009.
3. The adverse effects were widespread, with declines in the number of companies receiving initial and follow on venture capital financing, the amount of financing VCs provide, the size of initial and follow on rounds, and the share of businesses experiencing down rounds.
4. Though improving, the situation remains worse than when the recession began in the fourth quarter of 2007.
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Scott Shane is A. Malachi Mixon III, Professor of Entrepreneurial Studies at Case Western Reserve University. He is the author of nine books, including Fool’s Gold: The Truth Behind Angel Investing in America ; Illusions of Entrepreneurship: and The Costly Myths that Entrepreneurs, Investors, and Policy Makers Live By.