San Diego Union Tribune: Slowdown in Venture Capital Seen in San Diego

January 24, 2006

Slowdown in venture capital seen in San Diego 
More sluggish here than nationwide, survey says
By Bruce V. Bigelow
January 24, 2006

Venture capital investments in San Diego slowed significantly during the last half of 2005, an indication the region might have fallen out of sync with a steadier trend of venture funding nationwide.

Venture capital invested in local startups amounted to $266.7 million in the last three months, a 24 percent decline from the same quarter in 2004, according to a MoneyTree Survey released yesterday. The third quarter was down by about 13 percent in San Diego, according to the survey. 
Nationwide, venture investments in the fourth quarter were almost $5.1 billion, a 10 percent decline from 2004, according to the survey prepared by PricewaterhouseCoopers, Thomson Venture Economics and the National Venture Capital Association.

A similar study of venture investing done by Ernst & Young and VentureOne showed a smaller, 3.8 percent decline in San Diego during the fourth quarter. However, that survey had reported a dramatic 41 percent drop in San Diego's venture funding in the third quarter of 2005.

Ernst & Young reported that capital invested nationwide during the fourth quarter – $5.31 billion – was a 3 percent gain over the same quarter in 2004.

For the year, the Ernst & Young survey showed a total of $897.12 million in 2005 venture investing for San Diego, representing a 25 percent decline from the $1.2 billion the firm counted in 2004. The MoneyTree Survey put San Diego's 2005 total at just more than $1 billion, marking a 15 percent decline from $1.2 billion in 2004.

In contrast, MoneyTree showed nationwide venture investments holding steady in 2005 at $21.7 billion, compared with $21.6 billion in 2004.

San Diego's downturn also was at odds with the nationwide trend charted by Ernst & Young, which showed $22.1 billion invested in 2005. That represented a 2 percent uptick from the $21.7 billion total in 2004.

Venture capital is a crucial source of early funding for technology-based startup companies, which typically use such investments to develop their technologies or launch their pre-revenue business operations.

Most venture capital firms raise their capital from limited partners, which include college endowments, pensions, institutional investors, insurance companies and wealthy individuals.

In San Diego, venture capital funding generally is viewed as a key local economic indicator because biotechnology startups and other nascent technology companies represent a fast-growth business sector with relatively high-paying jobs.

But it's probably too early to draw conclusions yet, said Marney Cox, chief economist of the San Diego Association of Governments.

"On the one hand, it sounds like we may be a little weaker going into 2006," Cox said. On the other hand, he added, overall venture capital funding for the year was relatively strong, due chiefly to a strong second quarter.

Some local venture capitalists also voiced doubts about the significance of the downturn.

"I don't get too excited about the quarter-to-quarter fluctuations," said Drew Senyei of Enterprise Partners Venture Capital in La Jolla. The long-term trend, he added, shows a healthy buildup of the venture community in San Diego.

Yet that seemed to be open to debate.

"The overall challenge that San Diego faces is the trend that's been going on since about 2002," said Stan Fleming of Forward Ventures, a life-sciences venture capital firm.

"We are going to see a downward trend in bioventure financing in San Diego unless we can build up our pharmaceutical infrastructure," Fleming said. He described the presence of such companies as Johnson & Johnson, Novartis and Pfizer as crucial to San Diego, and he lamented staff reductions made here last year by Merck and Biogen Idec.

"I think what it's saying is that '04 was an outstanding year, which leaves us flat with '05," said Don Williams of Ernst & Young's San Diego office.

Nationwide, venture investing has maintained a fairly steady state over the past four years, which is encouraging for Kate Mitchell of BA Venture Partners in Foster City.

"We really like the steady pace versus the bubbles that we have had in the past," Mitchell said during a MoneyTree conference call with reporters. "We like moving from a state of irrational exuberance to a state of rational, healthy optimism."

Venture investments in software companies remained the industry's single biggest category, drawing $4.7 billion in 2005. Even so, that was a 10 percent decrease from 2004. Venture capitalists also invested $3.9 billion in biotechnology last year, a 7 percent decline from 2004.

Much of the enthusiasm at the national level was generated by venture investments in consumer electronics and medical devices, Mitchell and others said during the call.

San Diego has relatively few startups focused on consumer electronics, said Paul Kedrosky, who closely follows venture investing at UCSD's von Liebig Center for Entrepreneurism and Technology Advancement. He added that the number of local medical device companies is swamped by the number of drug development startups.

Lackluster demand for initial public stock offerings also has tempered the venture capital industry's enthusiasm.

A total of 194 companies made their stock market debuts last year, a 10 percent drop from 2004, according to Renaissance Capital, a Greenwich, Conn., research firm. In 2000, more than 400 IPOs were priced.

That means venture firms are providing more funding to later-stage companies, said John Taylor, vice president of research for the National Venture Capital Association.

He compared the situation to "an entire generation of college seniors who have decided that in order to get a good job they need to spend a fifth year in college." So they return to their parents and ask for more money.

 The Associated Press contributed to this report


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