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Silicon Valley Venture Capitalist Confidence Index gives signals for Q1 2011

By Julie King |

Financial outlooks south of the border can be a strong indicator of what we can expect in Canada.

The latest Silicon Valley Confidence Index, a unique Index that shares actual "on the record" quotes from venture capitalists (VCs) and has proven to be a key indicator of things to come in the US economy,  is a good news story pointing to increasing confidence. The latest Index for quarter one (Q1) 2011 shows steady gains from the low seen at the end of 2009.

Since that time, with the exception of one quarter in 2010, there has been a steady rise in venture capital confidence amongst the San Francisco Bay Area venture capitalists surveyed. The Q1 outlook for 2011 continues to be a good news story, registering at 3.91 on the Index's 5 point scale.

Social media, mobile top areas of interest

What areas of interest are helping bolster confidence?

The Index found that while there was variance in confidence, many respondents pointed to -- not surprisingly -- the exuberance in social media and mobile sectors.

Other things that have helped create yet another increase in Q1 of 2011 are:

  • overall upward trends in broad economic measures and public financial markets; and
  • market growth opportunities that are supported by continued adoption by the enterprise and consumer of venture-backed technologies being developed (e.g. cloud, social, and mobile).

Index author, Mark V. Cannice, Ph.D., Professor of Entrepreneurship and Innovation with the University of San Francisco School of Business and Professional Studies and the Founder of the USF Entrepreneurship Program, notes that while there are some concerns over possible valuation "bubbles" in some sectors, the overall confidence increased based on the improving metrics of the venture capital business model (e.g. fundraising, investment, and liquidity.)

Input from Bill Reichert of Garage Technology Ventures is a good indicator of the current climate.

 “Venture capital has become a tale of two cities: It is the best of times, it is the worst of times, it is the age of wisdom, it is the age of foolishness …. or, possibly, three or four cities — consumer, enterprise, cleantech, biotech, etc.," says Reichert. "There is the consumer sector, which is thriving to the point of bubble-osity. And there is the rest of the entrepreneur ecosystem, which is either incredulous or envious of what's going on in social-mobile-gaming. Nevertheless, a rising tide is lifting all boats to varying degrees, and more capital seems to be coming back into the system, both at the bottom in the seed world and at the top from the institutional world. And from the corporate world, globally, there is a reawakened interest in emerging innovations."

Venky Ganesan of Globespan Capital had this to say:

“The story of venture capital backed start-ups is too early, too early, too early, too early, too late!!! Well Ladies and Gentlemen, the time is now. We have a perfect storm of opportunity created by the intersection of major technology trends (cloud, mobile, social) and the best exit market in a decade. To paraphrase Shakespeare, there is a tide in the affairs of start-ups which taken at the flood leads to fortune. Carpe Diem.”

Return on investment, sustainability, still important

Return on investment is always top of mind in the venture capital world, something entrepreneurs are encouraged to remember. The upward turn in part can be attributed to improving trends in the broader economy and improving financial markets coupled with dynamic trends in technology innovations.

Still, some concerns were raised over the sustainability of the venture capital business model.

Bob Ackerman of Allegis Capital One said venture capitalists had invested close to $15 billion more than what they had raised over the past three years, a trend that is not sustainable. There are concerns that this trend, if not reversed, could have a negative impact on the ability of start-ups to raise money.

"When combined with intensive competition for 4 engineering resources, there are some significant challenges in moving entrepreneurial innovation from concept to implementation,” said Ackerman.

An anonymous respondent thought the climate for follow-on venture financing was improving, but that there continued to be limited exit options.

In spite of the continued gain in confidence, Index author Cannice notes that the Dow Jones VentureSource reported a decline in the number of U.S.-based venture-backed companies achieving liquidity in the first quarter of 2011. More money was raised over last year, but that does not seem to have translated into increased liquidity.

Caution has not been thrown to the wind

Debra Beresini of invencor noted that most funds are still being cautious.

Another venture respondent had this to say about confidence:

 “The overall economy and financial markets are gaining steam and stability, but I am concerned about over-heating in certain technology sub-sectors. Anecdotally, valuations seem quite high, term sheets are dropping ahead of diligence, and there are overabundances of competing start-ups and pools of available capital. In contrast to the Bubble period, I think there are often real businesses and profits at the center of these sectors, but I am concerned about the valuations and competitive dynamics. Additionally, I am worried about the rise of secondary markets and transactions in illiquid private companies. I find the information asymmetry and potential for misaligned employee/shareholder incentives troubling. On the positive side, as hot as some sectors are at the moment, there are other sectors that are so totally out of favour that I suspect they will generate outstanding returns in the coming years.”

Not all sectors are thriving

Joe Mandato of De Novo Ventures responded:

“We are not of the woods yet in terms of enthusiasm and excitement in life science opportunities. Certain segments such as spine or other long regulatory-cycle specialties continue to face a slow financing process.”

A silver lining

Nonetheless, there is an upward trend, with particular enthusiasm in the social media and mobile spaces as noted above. These valuations may be "ahead of themselves", but they are still helping to drive venture capital prices higher in other sectors, helping enthusiasm amongst most market participants.

Strategic exits on the decline

The index also noted that the trend of strategic exits overshadowing IPOs slowed somewhat in Q1. The reason for this is not known -- it is likely either a momentary adjustment or an indication that increased entrepreneurial and venture capitalist confidence are prodding investors to wait for independent liquidity and higher returns.

Positive indications for 2011

Nonetheless, the confidence indicators are positive.

The large increase in the amount of fundraising in Q1 2011 from a year earlier points to a rise in "... confidence, capability, and perhaps patience of the limited partners who provide the fuel to the innovation machine of Silicon Valley."

Index author Cannice concluded:

"The trend of increasing IPO exits, increasing LP funding, higher valuations and increasing venture investment, along with increasing VC confidence points to a healthy venture capital business model and portends an exciting year in the venture world. These positive trends will end eventually, but not this year."

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