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Portfolio rebalancing continued in 200523/08/2006. Source: Ernst & Young, Dow Jones VentureOne . 
 The venture capital industry in the US, Europe and Israel continued its pattern of healthy consolidation over the course of 2005 with a declining number of companies hanging around in venture capitalists' portfolios over the past six years as investors made room for new companies, according to the annual Venture Insight study from Ernst & Young and Dow Jones VentureOne.
Contributing to that portfolio consolidation is the smaller number of active venture capital investors today compared to 2000. The pool of active investors has declined 46% in that time period.
The Venture Insight study measures the number of active companies in venture capital portfolios each January 1, in the U.S., Europe, and Israel, and the cumulative dollars invested in them to date. To be counted in the pool, a company must be privately held, venture-backed and have received at least one round of financing in the past six years.
In the U.S., the pool of venture-backed companies stood at 5,406 companies with a cumulative $132 billion invested in them as of this January. When compared to 2005's January 1 pool, the number of companies decreased by 3% and the amount of cumulative capital investment they represented declined by 1%. In Europe, the number of companies stood at 3,598 with $31 billion invested (EUR 26 billion), which are declines of 8% and 7%, respectively, from Jan. 1, 2005. In Israel, the study found that the number of companies declined 9% to 428 although the cumulative amount invested in them stayed relatively flat at $8 billion.
The rate of decline is not as dramatic in 2005 as it has been in the past. Going back to 2002, the number of U.S. companies has shrunk by 11%. The European pool has narrowed 20% since 2003. And the Israeli pool has contracted 18% since 2004.
One of the most significant findings of the Venture InsightŪ study is the fact that there are 1,912 companies in this global pool that have not received a round of financing since 2000 or 2001. They represent about $51 billion of the cumulative investment. These companies appear to be long overdue for an exit, although many of them are profitable, and more consolidation of the historic pool of companies is to be expected in the years to come.
"Certainly the exit climate has improved of late, particularly for technology company acquisitions in the U.S. and public market exits for both healthcare and IT in Europe," noted Steve Harmston, director of global research for VentureOne. "However the exit opportunities are not likely to grow to the level that would be needed to see a substantial return for that remaining number of portfolio companies."
In terms of investment, certain segments of the pool have increased in that time period, particularly in the U.S. and Europe. For example, in the U.S. the pool has changed since 2002 with increased electronics and semiconductor companies, which are up 12% and 9%, respectively, reflecting the increased interest in storage, mobile and consumer devices. In addition, the healthcare category has gained. Both biopharmaceutical and medical devices companies are up 27% since 2002 -- the largest increase among industry segments.
In Europe, the biopharmaceuticals and medical devices segments showed some gains since 2003, particularly in capital invested. Biopharmaceuticals gained just two companies, a 0.4% increase, but with EUR 700 million in invested capital, a 14% increase in capital invested. Medical devices gained seven companies, a 3% increase -- the largest of all the industry segments -- and a 20% increase in invested capital.
"Although there is an overall reduction in the pool of venture backed companies, we are seeing significant growth in certain industry segments, indicating that investors are rebalancing their portfolios in favor of promising new start-ups," said Gil Forer, Global Director of Ernst & Young's Venture Capital Advisory Group. "In fact, 2005 may represent a turning point. As the $25 billion raised in new venture funds in Europe and the U.S. last year begins to be deployed, we may see the global pool of venture-funded companies change direction as new innovative companies garner investment and enter the pool."
"The contraction in the number of companies also increases the chances of the remaining winners to achieve market leadership through strategic acquisitions, the ability to penetrate new markets and the delivery of innovative customer need-based products and services," added Mr. Forer
For the overall pool, most of the contraction in all three regions has occurred in the information technology and products and services industries. In the U.S., the number of IT companies declined by 12% and the number of products and services companies declined by 36% since 2002.
In Europe, the number of IT companies in the pool since 2003 declined by 21% and products and services companies are down by 31% in that period. In Israel, IT is down by 15% and products and services by 33% since 2004.
Healthcare companies, on the other hand, have actually increased by 14% since 2002 in the U.S. and the number has remained relatively flat in Europe since 2003 and in Israel since 2004. In all three regions, the cumulative capital investment into healthcare has increased over the same periods.
POOL OF INVESTORS
As a complement to the Venture InsightŪ study, the research also looked at the number of venture capital investors active in the industry. Along with the consolidation of companies, this number has contracted as well.
Between 2000 and 2006, the overall number of firms making investments in U.S. companies declined by 49%. During the same period, the number firms investing in European companies dropped by 52% while the count of active investors in Israeli companies fell by 57%. Important to note, however, is that the rate of decline for investors slowed in the U.S. and Europe over the course of 2005 and appears to be flattening out.
In contrast to investments, the number of active investors declined across all major industry segments. However, those investors active in the healthcare segment declined the least.
"The fundraising pattern in 2005 made clear that new funds are mostly concentrated in the hands of a relatively small number of large investors. And that is likely to continue in the future as we see more deals among fewer investors," said Mr. Harmston.
"The sharp decline in the number of active investors indicates a shakeout in the venture capital industry. Like the contraction in the pool of venture-backed companies, the reduction in active investors is healthy for the industry overall. Investors who joined the game during the bubble and failed to establish a successful track record are exiting the industry while a new breed of experienced investors are entering it by breaking away from established firms and raising first-time funds," added Mr. Forer.
The investment figures included in this release are based on aggregate findings of VentureOne's proprietary U.S. research and are contained in VentureSource. This data was collected by surveying professional venture capital firms, through in-depth interviews with company CEOs and CFOs, and from secondary sources. These venture capital statistics are for equity investments into early-stage, innovative companies and do not include companies receiving funding solely from corporate, individual, and/or government investors. No statement herein is to be construed as a recommendation to buy or sell securities or to provide investment advice.
Dow Jones VentureOne, a unit of Dow Jones Newswires, has been the leading provider of finance and investment data to the venture capital industry for almost 20 years. Dow Jones VentureSource, a sophisticated electronic database on the venture capital industry, is published by VentureOne.
Ernst & Young, a global leader in professional services, is committed to restoring the public's trust in professional services firms and in the quality of financial reporting. Its 106,000 people in 140 countries around the globe pursue the highest levels of integrity, quality, and professionalism to provide clients with solutions based on financial, transactional, and risk-management knowledge in Ernst & Young's core services of Audit, Tax, and Transaction Advisory Services. Further information about Ernst & Young and its approach to a variety of business issues can be found at www.ey.com/perspectives.
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