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Venture capitalists emerge from slumber, vie for startups' attention

By Tricia Duryee
Seattle Times Eastside business reporter

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In the first quarter, more money was invested in young Washington-based companies than in any quarter in the past three years. As a result, investors are seeing a phenomenon that's been largely missing for what feels like ages: competition.

"This is all pretty exciting stuff; we went through a period where every week a company was going out of business. Now we are in interesting times," said Tony Audino, managing director at Voyager Capital in Seattle.

In Washington, venture-backed companies raised $259.9 million in the first quarter, or about 1-1/2 times the $166 million raised in same quarter last year and 60 percent of the total raised in all of 2003.

The numbers, being released today, are from a quarterly venture-capital report by Ernst & Young and VentureOne, a San Francisco-based research group.

Venture capitalists are finding that because of an increased appetite to make more deals, other VCs are often interested in the same business. "It's competitive out there again," Audino said.

Typically, VCs are busy in the first quarter holding annual meetings and sorting out their taxes. But not this year.

"People are just working harder," Audino said. "If you don't stay focused on the deals, you might miss some opportunities."

This is a tectonic shift from the past three years. For a long time, venture capitalists were spoon-feeding small amounts of capital to companies for short-term goals.

Now, companies are not only getting attention from one investor, but from two or three at one time. The increased attention appears to have started in the fourth quarter of 2003 and grown more intense in the first quarter of 2004.

One sign of activity is the growing number of term sheets, documents an investor draws up that explain the equity structure and assign a price for the startup company.
 
Audino said that during the first quarter, two out of the three term sheets Voyager put on the negotiating table were rejected for others.

John Steel, a partner at the law firm GrayCary in Seattle, said he, too, has witnessed this kind of action. Last week, he saw a situation in which a company received three competing offers. He said he didn't know which one was accepted, but it wasn't his client's.

"It's the first situation I've seen like that in a long time, so it may be a complete aberration, or it could be an indication of something frothy," Steel said.

With competing offers, a company may be able to raise more money than expected. That's at least partly reflected in the first-quarter numbers. The roughly $260 million invested involved 21 deals, whereas in the fourth quarter the same number of companies received far fewer dollars, $104 million. That means, on average, each deal in the past quarter meant a lot more money for the young company.

Among the big deals completed during the quarter were Bellevue-based 180solutions' $40 million, Seattle-based Isilon Systems' $15 million, Seattle-based Speakeasy's $24 million, and Kirkland-based Cardiac Dimensions' $15 million.

Health care sees big gains

Health-care companies saw the biggest uptick in median dollars invested in a round. In the first quarter, the median was $10.5 million, compared with $6.5 million in the fourth quarter. Information-technology investments also saw an increase, taking in a median of $4.53 million, up from $1.7 million in the previous quarter.

Overall, health-care companies received more dollars than IT for the third time since 1998. Health care, which includes pharmaceuticals and medical devices, received $108.2 million during the quarter, while IT, which covers software and communications, received $98.1 million.

Mark Heesen, president of the National Venture Capital Association, said the amount of money pouring into health care needs to be watched closely.

"We are seeing major changes in the industry. Is it another bubble? That's always a concern," said Heesen, who sponsors another survey, MoneyTree, which is expected to be released tomorrow.

Heesen said a bubble can occur when any number of factors develop: There is competition for deals; the competition leads to increased valuations assigned to companies; investors look outside their traditional sectors to invest; and more than one startup enters a specific market.

Steve Arnold, managing partner at Polaris Venture Partners, which has offices in Seattle and Boston, said although there has been discussion about a bubble in health care, it has not quite reached the urgency IT experienced a few years ago.

"I would certainly say there is more heat in medical than in the IT market, but I wouldn't classify it as a bubble yet. Ask me in six months," he said.

Arnold said one encouraging sign, particularly in the IT sector, is that despite the intensified competition for a deal, VCs are assigning close to the same valuation on a given company. That means inflation has not occurred.

However, that was not the situation for Audino. He said that in both circumstances where his term sheet was not chosen, the deal accepted had a higher valuation.

"I think we've done a good job positioning with the entrepreneur. The issue is pricing," he said.

Key factors at work

Feeding the investment flurry is a handful of factors. Public markets have improved, there's a lot of money still available to invest and a limited time in which it has to be invested, and the perception is the economy is turning a corner.

Nationally, there was an uptick as well, but not as pronounced as it was locally. In the first quarter, investors poured in $5.1 billion, a 25 percent increase compared with the same period a year earlier, when about $4.1 billion was invested.

Much of the current money flow comes from the pool investors have available, but haven't invested until now. Called "the overhang," this pool is estimated to be about $68 billion, according to VentureOne.

The National Venture Capital Association's Heesen said there is pressure on VCs to put this money to work. A venture fund typically has a 10-year contract, with investments to be made in the first five years. The second half is when investors reap their returns.

A lot of these funds were created in 1999 and 2000. That would make either this year or next the final year they are allowed to invest, he said.

Audino said the economy is clearly returning and companies have started to spend more money. This has encouraged entrepreneurs to start companies.

More startups born

Laura Puckett, who works with Steel at GrayCary, said she sees the renewed growth in the number of startups as one of the main drivers in the return to investing. She said that, during the past quarter, she herself has helped to incorporate five companies here.

Jon Staenberg, who was part of a $20 million investment in Seattle-based EYT as a partner at Rustic Canyon Partners in Seattle, said he would like to see more financing deals before the caution flag goes up.

Time to panic?

"I think it's a little early," Staenberg said. "People are still breathing a sigh of relief that they are starting to see more company formation. Ideas are getting funded in a pretty healthy way. We don't need to be too cautious yet. I would like to see more."

Tricia Duryee: 206-464-3283 or tduryee@seattletimes.com

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