ANN ARBOR ? Through the third quarter of 2005, 147 deals were closed in the Midwest for $640 million, 3.92 percent of the total dollars invested nationwide. The region?s performance in the quarter lagged its year-to-date results.
In the third quarter, the region closed 37 deals raising $122.4 million, or 2.31 percent of the nation?s total. While we funded 27 initial deals for $47.2 million YTD and 2.1 percent of the nation?s total, the quarter totals fell to 9 deals for $18.5 million, or 1.26 percent of the grand total. This data came from Thomson Financial, the National Venture Capital Association, and VentureOne, and are considered to under-report the actual numbers and amounts of venture funding actually done.
Clearly, California dominates venture capital investment in the US and world. This concentration of investment in California provides an efficient idea-to-market engine, and both financial and human resources are naturally drawn to these areas for investment and employment. The state accounts for 50 percent of the third quarter?s US investment, five times that accounted for by Massachusetts, the runner-up state.
A number of states and regions have developed their venture capital activity to a greater level than the Midwest (for example NY, PA, NC, FL, TX, MD/DC and others). This activity reflects the conversion of innovative ideas, whether based upon ?hi tech, lo tech or no tech?. While our Midwest region represents a minor portion of the national venture capital investment market, a large number of states are even lower on the venture capital ladder. During the quarter a number of states (AK, IA, KS, ND, OK, and SD) reported no deals done, while others reported only one (AL, LA, ME, MS, MT, NE).
As foreign countries develop critical mass in educational institutions, pure and applied research, and dedicated finance, they will attract the ?best and brightest? from their own and other countries. The ?winners? in this competition will produce the growth companies that the US and other countries need to spawn in order to attain and keep a competitive position in an increasingly ?flat? world. It is quite possible, in the years ahead, that CA?s major competition will come from other regions of the world as well as from other parts of the US.
The basic message to understand is that the Midwest region and the other states and regions of the US must realize that we are engaged in co-opetition with the rest of the world. We must partner effectively with these countries in R&D, market extending and company-building. Our universities, financiers and companies, both established and emerging growth companies, must learn how to operate in this new world. We must get better at building better companies!
The venture capital market has stabilized greatly since the sharp decline of 2000, and is gradually recovering from its post-2000 lows. Venture capital returns for 1 and 3-year horizons are low single-digit positive, although the 5-year return is still negative. The bulk of VC investment is still in later-stage deals, as might be expected. As shown above, however, initial venture funding is gradually gaining favor across the country. The rate of such investment is probably under-reported due to ?stealth? investment policies. These stem from an unwillingness of VC general partners to disclose publicly any new ?hot? areas of investment, for fear of attracting institutional investment to the space and thereby causing valuations to rise quickly.
In the face of a weak IPO market, the most favored harvest route for venture capital-backed companies is the merger and acquisition (M&A) market, where competition for deals is producing attractive valuations for sellers.. Perhaps reflecting the conservative growth of the market, with low volatility, institutional investment in both venture capital and buyout funds is steadily rising, surpassing the 2004 level after third quarter 2005. Cautious of the over-funding excesses of the late 1990?s, investors and fund managers seem to be tailoring new investment in funds to the rate at which those funds can be invested. For example, the amount of nationwide investment indicated above YTD 2005 ($16 billion) is on track to roughly equal the amount of fund-raising expected by NVCA for 2005 ($18 billion).
The Midwest region deals highlighted below reflect the gradual growth of the VC market across the country. Our expectation is that we will see a strong focus by Midwest regional funds on investment in companies in the early stages of their life, with these companies then drawing investment interest on the part of VC funds from other parts of the US and from other countries. As we prepare for the upcoming Michigan Growth Capital Symposium, we will track further trends in institutional VC investing and bring them to you through this Journal.
This column was written by David Brophy Dr. David J. Brophy, MBA, Ph.D., Director of the University of Michigan Business School Center for Venture Capital and Private Equity Finance, and is a member of the executive committee for the Zell-Lurie Institute for Entrepreneurial Studies. Brophy is the host of the Michigan Growth Capital Symposium. This column was published in the Growth Capital Journal, the quarterly eNewsletter published by MGCS. For more information, click on MichiganGCS.Com
