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Mid-Atlantic VCs report growth on horizon22/11/2006. Source: MAVA.
 US investors maintain positive outlook on the market and expect increases in new investments, exits and size of funds.
The Mid-Atlantic Venture Association's Q1 2006 MAVA VC survey, reveals that venture investors anticipate an increase in new investments to be made in the coming quarter and an exit market that is expected to strengthen throughout the year. Venture investors also reported spending more time examining new deals rather than aiding and growing their existing portfolio companies, even as more respondents felt valuations were considered overvalued. The majority of survey respondents are fundraising in 2006 and plan to raise larger funds than their previous funds.
"The mid-Atlantic's venture investors, encouraged by several critical market indicators which point to the region's health and viability, are illustrating their desire for increased investment levels and necessary liquidity events in this quarter's survey results," said Julia Spicer, Executive Director of MAVA. "As the majority of our investors participate in their own fundraising activities this year, a large amount of capital will enter the market, thus the rise in valuations and 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 Q1 2006 survey was conducted via email and distributed to 429 member VCs using WebSurveyor, and received a 12% response rate.
Survey's Major Findings
Deals: Investments Down, Forecast Up
Survey respondents reported deal activity in Q1 2006 which fell short of forecasts, although investors continue to be confident looking forward to next quarter. Fifty-three percent of respondents reported participating in at least one deal in Q1, a contrast from Q4 2005 when 73% reported having closed at least one deal. A year-over-year comparison, however, reveals that the first quarter of 2005, with 58% reporting closing at least one deal, was comparable to Q1 2006 with 53% closing at least one deal.
The most commonly cited explanation for the downturn in forecasted closings was that "the viability of the investment shifted during the due diligence process" (37%). Respondents also attributed the shortfall to general timeline delays, negotiation hurdles that impeded reaching an agreement on deal terms, competitive deal dynamics and high valuations.
The outlook for investment activity in Q2 2006 remains optimistic, with 90% of investors predicting participation in at least one new deal. Of the deals forecasted for Q2 2006, almost half of respondents expect at least 60% to be in the mid-Atlantic region and, consistent with the Q1 2006 forecast, 44% responded that between 60 and 100% of their anticipated deals will be in the mid-Atlantic, reflecting an increasing to stable trend of local investment activity as a fraction of all deals.
Deal Flow: Stable with Valuations Overvalued
VC sentiment around firm deal flow varied this past quarter. While opinions are mixed, 40% of respondents reported that their firm's deal flow remained the same, indicating improved stability relative to Q1 2005, when only 29% of respondents described deal flow as steady.
While VC opinions of valuations have persisted over recent quarters, Q1 2006 survey data saw a sharp increase in the number of respondents describing valuations as "slightly overvalued," jumping from a recurring figure of approximately 50% since Q2 2005 to 62% in Q1 2006. Correspondingly, the number of responding VCs that characterized valuations as "on target" declined from a recently steady mid-40 percent to 32%. VCs partially attribute this change in their view of company valuations to last quarter's light deal activity. Overall, a majority of respondents continue to characterize valuations as "slightly to considerably overvalued," with 66% holding this view in Q1 2006, an increase of about 10% compared to the last three quarters reported.
New Deals: More Time Spent, More Early Stage
Last quarter investors allocated proportionally more time to looking at new deals than the previous quarter, with 63% of respondents spending more than 40% of their time examining new deals in Q1 2006 versus 48% in Q4 2005. At the end of 2005, over half (52%) of respondents allocated less than 40% of their fund efforts to sourcing new deals and focused largely on growing and aiding their existing portfolio companies. This past quarter, however, the general focus appears to have shifted more towards finding new investment opportunities and proportionally less on developing the current portfolio.
While investors want more deal flow at all stages in which they actively invest, early-stage deals continue to generate the most interest, according to our respondents. When asked at which stage or stages they would desire more and better deal flow, more respondents selected early stage than any other. Fifty percent (50%) wanted more early-stage deals, but the survey also revealed a relative increase in interest for deals at the expansion (46%), late (27%), and buyout (15%) stages.
Exits: VCs Continue Positive Vibe
Recently published figures for venture-backed liquidity events in Q1 2006 were generally lower than the respective numbers for the first quarters of 2005 and 2004. However, when queried on how they expect overall liquidity activity in the mid-Atlantic to shift over the remainder of the year, 41% of respondents expect exit activity to strengthen while 42% expect no foreseeable change in overall exit activity for the upcoming quarters.
Projections for exit activity over the next year are relatively positive, with 74% of investor respondents estimating that 20 to 60% of their portfolio is well positioned for an exit over the next twelve months. Investors are more optimistic about exit activity over the next twelve months than they were a year ago in Q1 2005, where 56% of respondents estimated that less than 20% of their portfolio would undergo a liquidity event over the following twelve months.
Several VC respondents offered the following thoughts, by way of explanation, for the anticipated positive shift in exits:
"The economy is strong and many from the 2000-2001 class of companies are reaching harvest stage."
"There is a build-up of solid companies that have withstood the economic downturn and continue to grow."
"We see the bad deals going away, and if the economy continues to be stable, the better deals will get commensurately better prices."
State of the Market: Positive, 4 Years Running
In general, VC sentiment around the investment climate in the mid-Atlantic region continues its four year positive trend, with 69% of Q1 2006 respondents describing the region to varying extents as "on the upswing." Twelve (12%) of respondents in Q1 2006 felt the market was "fully on the upswing," as compared to 5% in Q1 2005, 0% in Q1 2004 and 0% in Q1 2003.
A change in the perceived view of the market as "flat" has increased slightly this year to 29%; up from 12% in Q1 2005 and 10% in Q1 2004. However, this year's results of the "flat" view are a marked decrease from the high of 56% in Q1 2003.
Fundraising: Larger Funds Being Raised
While fundraising timelines among investors are mixed, a majority of responding VCs are either currently raising a fund or will begin the process this year (53%). Seventy-seven percent (77%) of respondents anticipate that the fund they are targeting will be larger than their previous fund, compared to only 26% in last year's survey. In Q1 2005, 71% of VC respondents expected to raise a smaller fund than their previous.
Based on current fundraising activities and feedback from their Limited Partners (the investors who allocate money to VC funds), survey respondents identified that a fund's track record with delivery on a coherent strategy and performance were among the most critical issues on the minds of their Limited Partners.
The Future: Opportunities & Challenges
Survey respondents offered their outlook on opportunities and challenges facing the mid-Atlantic venture environment in the forthcoming quarters. Their comments identified key opportunities and challenges that will likely affect the mid-Atlantic investment climate and venture community in the short-to- medium-term. Among the areas of opportunity identified by respondents, the most commonly cited include the life sciences and biotech, security, and wireless technology sectors. In identifying challenges, respondents pointed to quality of management teams, overall risk aversion, and shortage of quality deals as key areas of concern.
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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