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US VCs Continue Optimism about Market Recovery

Data released by the Mid-Atlantic Venture Association (MAVA) indicates that private equity investors in the region continue to have a positive attitude about market recovery, as evidenced in the results from nine consecutive quarterly surveys. In this quarter's results there was early evidence of possible stabilization in market growth via several indicators such as valuations, merger and acquisition activity, and deal flow activity.

Additionally, regional VCs picked up their investment activity in Q3 and forecast an active fourth quarter.

"VCs continue to be focused on the long-range cycle of private equity investing and understand that market improvement builds over time," said Julia Spicer, Executive Director of MAVA. "As VCs work on deals, they are taking their time to do proper due diligence and even though valuations appear to be leveling off and term sheet competition continues to be strong, funds are being careful to place their money wisely".

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 Q3 2004 survey was conducted via email to 336 member VCs using WebSurveyor, and received a 15% response rate.

Survey's Major Findings

Investment Activity Increasing; Q3 Uptick and Forecast Strong for Q4 2004
Regional investors were more active in Q3 compared to the previous quarter, with the survey results showing that 82% of respondents completed one or more deals in Q3 2004. When asked for their year-end forecast on how many new deals they anticipate doing in the next quarter, VCs indicated they would continue the upward trend in activity, with 96% participating in at least one deal.

Overall Feelings of Market Optimism
For the ninth consecutive quarter, survey respondents are continuing their positive trend toward market recovery, with 6% saying that we are "fully on the upswing" and 42% saying "on the upswing but uncertainty remains." For the first time in the survey's history, no respondents (0%) felt that the market was "still declining."

Over the course of the previous nine quarterly surveys, there has been a slowly decreasing percentage of VCs that feel the market is "flat, but scrapping the bottom," but this quarter the responses in this category registered a slight up-tick to 18% compared to 8% from the previous quarter.

Several Market Growth Indicators Point to Stabilization
In this quarter's survey responses, several categories indicating market growth have shown signs of possible stabilization. While valuations and deal flow still appear to be healthy, slight decreases in both categories were noted. VCs feeling that "valuations are rising" fell to 54% this quarter from 63.8% the previous quarter. An increase of almost 10% was evident in the "valuations are flat" category with 30% of VCs feeling that there has been "no increase or decrease in valuations."

Additionally, this quarter, VCs report a slight decrease in deal flow volume, with those receiving 100-200+ plans per month falling approximately 2% in each of the 3 categories for largest number of plans. A slight uptick in volume of deal flow proposals was seen in the smaller categories of "less than 50 per month" and "50-99 per month" indicating a shift in deal flow to lower levels of business plans/proposals being submitted to VCs this past quarter.

However, contrary to the above-mentioned indicators, survey respondents indicate continued strong competition in term sheets, with an increase from 18% in Q2 to 22% in Q3 for "companies routinely receiving" competing term sheets. VCs indicated that 60% of "companies occasionally receiving" competing term sheets, up from 50% in Q2. With this increased competition in the market place, VCs might shorten the timeframe it takes to close a new investment in order to be included in a deal, but the opposite was true this quarter. In fact, we found that the length of time it takes a VC to close a deal had increased with a slight shift in the average 4-6 month time period to 7-9 months.

VCs Indicate Many Investments Ready for Exit

In the Q3 2004 survey results, a growing percentage of VCs anticipated their portfolio companies to have an exit over the course of the next year. Forty-six percent, increasing from 30.3% in Q2 2004, believe that 25-40% of their portfolio is well positioned to exit and 10%, up from 2.2% in Q2, believe that 40-60% of their portfolio is well positioned to exit over the next year.

When survey respondents were asked about the viability of an IPO for any of their investments that were expected to exit in the coming year, 40% said they expected a portfolio company to exit via IPO, 42% said they did not anticipate an IPO in their portfolio and 18% were unsure if an IPO may be an exit path for their companies.

VCs indicated that the merger and acquisition market still is healthy, although responses this quarter compared to last quarter indicates that activity may be slowing. Survey results showed that 6% saw a "large increase" in M&A activity and 60% saw a "slight increase." In both categories, we saw a slight decrease from Q2 responses of 15.3% seeing a "large increase" and 71.5% seeing a "slight increase" in M&A activity. Compared to the previous quarter, respondents that felt that they saw "no increase" in M&A activity, increased by 12.4%, from 3.6% in Q2 to 16% in Q3 2004.

Fundraising Timeline Targeted and Size of Fund Possibly Increasing
Survey results this quarter show an increase in the number of firms that plan to fundraise in 2006, 2007 and later. There has been a slight decrease in the firms raising funds in 2005 pointing to the possibility that some funds have chosen to move out their timeframe for fundraising.

The most notable change in the responses to this quarter's survey in the area of fundraising was found in the estimated size of the new fund. When VCs were asked about the anticipated target size of the new fund, there was an increase in the responses for larger-sized funds, with funds in excess of $200M increasing by 16.7%. There were also corresponding decreases in the percentages of firms that plan to raise funds in the $25M-$199M range.

MAVA represents the collective interests of venture capitalists with investment interests in DC, Maryland and Virginia. Founded in 1986, MAVA provides a wide range of programs, information and forums designed to facilitate quality deal flow, encourage collaboration, and foster solid relationships with key service providers in order to promote private equity investment. For more information on MAVA please visit www.mava.org