Business Tech

This was originally posted at ZDNet's Between the Lines.

Venture capitalists are becoming slightly more upbeat about the economy and market, according to the latest read from the Silicon Valley Venture Capitalist Confidence Index, which was released Wednesday.

The ongoing survey of VCs in the San Francisco Bay Area found that venture capitalist confidence registered a 3.03 on a 5-point scale (5 shows high confidence). The first-quarter read was up from the fourth quarter's tally of 2.77, which was a five-year low. (See report overview, PDF).

(Credit: Silicon Valley Venture Capitalist Confidence Index)

Is it party time? Not quite.

University of San Francisco professor Mark Cannice writes:

This mustard seed of hope appears to be taking sprout among a majority of the venture capitalist respondents who provided their insight to the March 2009 survey. And it is nurtured by venture capitalists' faith in the resilience of entrepreneurs to build efficient enterprises with disruptive solutions, more modest expectations for growth and valuations, and the early stages of a stabilization in the financial system. Most importantly, this hope is leading to a more optimistic climate and new investments, with numerous VCs believing that great companies tend to be launched in difficult economic environments. As venture capitalists take a long term perspective in shepherding their portfolio firms over years rather than quarters, investments made today are expected to grow and blossom on the other side of the current economic malaise. The modest but measurable uptick in confidence in Q1 breaks the extended decline and provides an important step toward new entrepreneurial growth opportunities.

Judging from the VC comments collected by Cannice it appears that:

• VCs think the global economic crisis has stabilized.

• But the economy is still an overhang.

• Great companies will emerge in the economic wreckage.

• And investments are like roach motels: There are no exit strategies.

With venture-backed companies failing to launch IPOs and with mergers and acquisitions lagging, liquidity for venture capitalists fell 65 percent in the first quarter, according to a report released Wednesday by Dow Jones VentureSource.

During the first quarter, $3.2 billion in liquidity was generated--a sharp contrast with $9.1 billion from a year ago and around the level seen in 2003. Because no initial public offerings took place in the first quarter, all of the $3.2 billion was generated from venture-backed companies selling themselves to the highest bidder.

Those two types of transactions are how VCs and investors in VC funds make their money back, after nursing those companies along with funding. The fewer of those types of transactions, the less money that VCs and their investors make.

Jessica Canning, VentureSource's global research director, said in a statement:

The most disturbing part about these new liquidity figures is that we've already reached the lows seen after the dot-com bust and we may not be at the bottom yet.

The IPO market is totally closed and there's just no clear indication right now that it will revive any time in the next quarter or two, even with 43 companies currently in (IPO) registration. It's a tough time to be a venture capitalist - and likely even tougher to be an investor in a venture fund.

With no venture-backed companies launching IPOs in the first quarter, all the activity fell to mergers and acquisitions. During the quarter, 68 mergers and acquisitions took place, substantially down from the 104 completed a year ago.

"This is due to the fact that many public technology companies are focused on conserving capital and the few that are buying venture-backed companies are doing so for lower prices," Canning said of the plunge.

The median price paid for a venture-backed company was $22.1 million in the first quarter, compared with $60 million a year ago, according to VentureSource. That's a steep 63 percent decline.

While the amount of money companies raise through a sale or IPO is down, venture capitalists may find comfort in that the time it takes for their portfolio companies to provide liquidity is shrinking.

In the first quarter, the median amount of time it took for portfolio companies to provide money back to their VCs was 4.7 years, compared with 6.8 years as was the case a year ago, according to VentureSource.

Y Combinator on Monday announced that it has raised a $2 million venture fund with the aid of Sequoia Capital and angel investors.

In making the announcement, Y Combinator noted that it plans to increase the number of start-ups it funds to 60 a year, up from 40.

For Web services and software start-ups, that may bode well. Y Combinator focuses its investments on those two sectors and funds companies that are in their early stages.

As it notes, one unusual twist to this venture firm is its reliance on the strength of entrepreneurs' ideas, rather than on their business plans to support the ideas.

Y Combinator said it is ramping up its investments at a time when others are scaling back:

It's a big step for us to raise outside money. Till now, we'd only used our own. But we didn't want to let the bad economy make us conservative. Instead of hunkering down to wait out the recession, we want to expand to take advantage of it.

Y Combinator also noted that the quality of surviving start-ups is of a higher caliber during these economically trying times.

With the added funding in hand, Y Combinator extended its deadline for start-ups to apply for funding to March 25.

Israeli venture capitalists are expected this year to raise $300 million, setting the stage for a second consecutive year of decline, according to figures released Wednesday by the IVC Research Center.

Israeli venture capital funds are expected this year to post a 62 percent decline over last year, when $793 million was raised.

And should Israeli venture capital funds generate only $300 million, it would put it on par with levels not seen since 2003 to 2004.

(Credit: IVC Research Center)

Last year, Israeli venture capital funds declined 30 percent over the previous year, when $1.14 billion was raised.

But despite the two years of declines, IVC reports that roughly $1 billion in capital still remains available for investment. Of that pool of funds, approximately $400 million is targeted for first-time investments in high-tech companies. The remainder is set aside for follow-on investments in those companies.

Israel over the past decade has also attracted the attention of U.S.-based venture capitalists looking to invest in start-ups operating in the Middle East high-tech center.

Venture capitalists' confidence level took another hit in the third quarter, marking the sixth-consecutive quarterly decline for the Silicon Valley Venture Capitalist Confidence Index, which was released Wednesday.

The index fell to 2.89 points, nearing the midway point of a 5-point scale, with 5 ranking the highest confidence level.

According to Mark Cannice, associate professor of entrepreneurship and the founder of the University of San Francisco's Entrepreneurship program and author of the index, the faltering confidence level stems from several factors:

The unprecedented deterioration of macro economic conditions and the resulting impact on the venture capital business model were cited most often by this study's responding venture capitalists as the factors that negatively impacted their confidence in the near term environment for growth ventures.

While the lack of IPO exits has adversely impacted the (liquidity events) of the VC business model this year, the precipitous decline in the value of stock portfolios of some limited partners (e.g., pension fund asset managers) will likely limit the amount of capital committed to venture funds in the near term.

Since the first quarter of 2007, when the index stood at 4.38 points, the level of VCs' confidence has edged down every quarter. And in the last four quarters, the index has hit new lows since it was created in 2004. The index was derived from a September survey of 33 San Francisco Bay Area venture capitalists.