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Mid-Atlantic VCs forecast increase in regional investments and exits21/03/2006. Source: MAVA.
 Data released by the US Mid-Atlantic Venture Association indicates growth in investment activity in 2006 with more in-region financings and liquidity events predicted.
In the Q4 2005 MAVA VC Survey, venture investors spent proportionally more time aiding and growing their existing portfolio companies than examining new deals, as valuations continued to be stable but considered slightly overvalued. Some investors report diversifying their investment strategies, with the majority indicating a preference for early-stage deals. Optimism about liquidity events increases, with merger and acquisition activity in the mid-Atlantic region described as stable and strengthening.
"Investors in the mid-Atlantic remain bullish on the investment climate of the region, demonstrated by their intention to invest in more regional deals as the horizon for exit opportunities brightens. 2005 closed with impactful public and private transactions as seen with the local IPOs of Vocus and UnderArmour and the completed merger of MCI and Verizon," said Julia Spicer, Executive Director of MAVA. "As liquidity events occur, venture capitalists return capital to their investors, talented entrepreneurs become available in the market and the life cycle of private equity investing continues, as evidenced by sustained investor interest in early-stage deals."
The venture capital survey is part of MAVA's ongoing efforts to better assess the climate for private equity investing in the mid-Atlantic region. While the purpose of other private equity surveys is to track previous investment activity, the quarterly MAVA venture capital survey is intended to gauge investor attitudes, future activity and important investment trends. The Q4 2005 survey was conducted via email and distributed to 473 member VCs using WebSurveyor, and received a 10.1% response rate.
Survey's Major Findings
Close of Year Investment Activity Weaker than Forecasted, Yet New Deals in Region Expected to Escalate in 2006
Despite weaker than forecasted Q4 2005 investment activity, both the overall number of new investments and in-region financings are expected to rise in Q1 2006. Investors continue to be confident looking forward into the next quarter. When asked for their forecast on how many new deals they anticipate doing in the coming quarter, VCs predicted high activity, with 91% of respondents expecting to participate in at least one deal.
Though investors did not close as many deals as they had expected, survey results show that VCs were still more active overall in Q4 2005 than in previous quarters, with 73% of responding VCs closing at least one deal in Q4 2005 versus 66% in Q3 2005 and 64% in Q2 2005.
Of the deals forecasted for Q1 2006, more respondents expect a high percentage to be in the mid-Atlantic region with 44% of respondents estimating that between 60 and 100% of their anticipated deals for Q1 2006 will be in the mid-Atlantic, versus 38% of respondents predicting greater than 60% of their deals to be local in Q4 2005 and an even lower 35% in Q3 2005.
The most commonly cited reason for not closing as many deals as expected was that "the viability of the investment shifted during the due diligence process." Several respondents claimed to have experienced general timeline delays but are still on track with forecasts for Q1 2006.
2006 Exit Opportunities Positive, M&A Activity Strengthening
Projections for exit activity over the next year are relatively positive, with 65% of investor respondents estimating that 20 to 80% of their portfolio is well positioned for an exit over the next 12 months. Investors are more optimistic about exit activity in 2006 than they were a year ago in Q4 2004, where 50% of respondents estimated that less than 20% of their portfolio would undergo a liquidity event in 2005.
Of their portfolio companies that are preparing to exit in 2006, 90% of respondents predict that over half of their liquidity events will be a merger or acquisition (M&A). These predictions are relatively consistent with investor sentiment of the prior quarter, Q3 2005, around the breakdown of exits as IPO or M&A, where 94% of respondents expected greater than 50% of their anticipated exits to be via M&A. A majority of respondents (70%) expect to maintain similar exit ratios of M&A to IPO in 2006 for their individual fund's portfolios and 57% predict that the ratio will also persist for the general market.
The M&A market in the mid-Atlantic region continues to grow, with only 4% of respondents describing M&A activity as declining. A majority of respondents note an overall increase in regional M&A activity, with 63% describing the current state of M&A in the region as either "increasing slightly" or "increasing significantly."
VCs Spend More Time with Existing Portfolio than New Investments
Last quarter investors allocated proportionally less time to looking at new deals than one year prior, with 54% of respondents spending less than 40% of their time examining new deals in Q4 2005 versus 27% in Q4 2004. At the end of 2004, 5% of respondents spent over 80% of their time looking at new deals whereas no respondents dedicated more than 80% of their fund efforts to scouting new deals in Q4 2005.
Responding investors focused more last quarter on growing and aiding their existing portfolio companies than to exploring new deals, with 71% spending 40 to 100% of their time dedicated to existing investments, as compared to 48% spending 40 to 100% of their time looking at new deals.
Investors Cite Slightly Overvalued Valuations, Define Criteria for Declining Deals
Survey results illustrate that VC opinion of valuations being stable but "slightly overvalued" has persisted over the past few quarters. A majority continue to characterize valuations as "slightly to considerably overvalued," with 55% holding this view in Q4 2005, 56% in Q3 2005 and 55% in Q2 2005. However, 45% of respondents describe pre-money valuations this past quarter as on target, which parallels the results in Q3 2005 and Q2 2005, where 42% and 43% of respondents shared this opinion, respectively.
When asked to provide the most common reasons for rejecting an investment under consideration in Q4 2005, the top two reasons remained consistent with their respective rankings from a year ago with 73% of responding VCs attributing their decline decision to deficiencies in the quality of the management team, keeping this as the number one factor. Lack of market potential followed as a close second in reasons for declining deals. The criteria "value proposition" and "product differentiation" became less critical as reasons for declining a deal, falling in rank from 5 and 4 to 7 and 8, respectively, since one year ago. The criteria "lack of clear proprietary technology," "revenue," and "market uncertainty" gravitated up in priority, shifting from positions 6, 7 and 8 a year ago to 4, 5, and 6, respectively.
Investment Strategies Become Diversified as Investors Seek More Early Stage Deals
While most investors continue to remain focused on their core areas of investment, survey results this quarter indicate that some VCs appear to be expanding the scope of their radar, whether through diversification in company stage, geography, or industry sector. In Q4 2005, 17% of respondents have been diversifying across company stages as well as geographies and 10% of respondents have entered new industry sectors.
Investors indicated their desire to see more deal flow at all stages, however early-stage deals are generating the greatest interest, according to our respondents. While 81% of VC respondents selected "early" as the stage of their current investment focus, a majority (56%) also expressed wanting more early-stage deal opportunities.
Triumphs and Challenges
Survey respondents offered their perspective on the mid-Atlantic venture environment both retrospectively and prospectively, highlighting the triumphs of 2005 and identifying the key challenges that will likely affect the mid- Atlantic investment climate and venture community in 2006.
Overall, VCs felt that 2005's triumphs included a stable and good market climate evidenced by several local exits and fundraising closings. As one respondent noted, "There were some high quality exits." VCs sentiments about the upcoming challenges in 2006 included attracting top management talent to their portfolio companies and the increase in competition for high quality deals. Also, notes one VC, "tapping into the vast technology R&D happening in the federal, university, and commercial labs to become a leader in technology transfer" will be a challenge in 2006.
MAVA represents private equity and venture capitalists with investment interests in the mid-Atlantic. Founded in 1986, MAVA provides a wide range of programs, information and forums designed to facilitate quality deal flow, encourage collaboration, and foster relationships with entrepreneurs and investors in order to promote private equity investment. Membership includes more than 500 venture capital professionals representing nearly 125 firms with collectively more than $10Billion in capital under management. In addition, more than 250 key professional service providers from the legal, financial, executive search and consulting fields are also MAVA members. For more information, visit www.mava.org
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