We  issued the latest edition of EEC Perspectives this week, looking at the first quarter of 2009.  I had the task of writing the (admitedly, somewhat rambling) cover piece titled "Get Your Pole Vaults Out," which I have pasted after the jump and welcome any comments on.   As you will see, numbers were down, but New England was not hit nearly as bad.  There have been a number of thought provoking blog posts about the numbers by others, for example:

Michael Greeley at Xconomy 
Furqan Nazeeri at Altgate
Adeo at TheFunded

Of course, beyond the broad numbers (which you can find elsewhere), their is valuable detail in EEC Perspectives about valuations and deal terms during the first quarter.      

Get Your Pole Vaults Out

The bar has been raised. That’s what VCs have been telling everyone since September. And it had started to show in the numbers in Q4 of 2008, but it really showed in the first quarter of 2009. As has been widely reported by various surveys, nationally, Q1 was the lowest investment level in more than a decade. While there are not good numbers available, it is reasonable to infer that angel investing has had a similar decline, if not worse. The good news is that the decline in New England has not been nearly as bad as elsewhere. Truly innovative companies are still getting funded, and this may be one way in which the science and techheavy New England area is distinguishing itself while softer tech plays that are more prevalent on the West Coast seem to have suffered more.

There has been a lot of talk about a shakeup in the VC community. Prominent VCs have been able to raise new funds, although often at lower levels than their initial targets. Less prominent firms have been having difficulty raising new funds, and some of them will inevitably quietly go away. This would suggest a shortage of investment capital and a chance for VCs to be more picky about where they put their funds.

From smart grid to cloud computing, there are some very hot spaces out there right now, that many VCs are looking at. But they have definitely broadened their focus to look at all sorts of things. I’ve seen recent announcements about a men’s custom shirts retailer and a cupcake company getting funding. Granted, these companies were outside of New England, but these are still not your typical venture play. That suggests to me that some of this shift is less about a shortage of VC money than a shock to the system that causes VCs to look longer and closer, and focus more on profitable, revenue-generating, business plans than trendy companies that have not yet figured out exactly how they will make money. The larger shortage, if you believe the VCs, is that, even though they are seeing more deal flow than ever, there is a limited number of good investment opportunities that fit the criteria for a successful VC investment. If there was a shortage of money, VCs would not be looking far and wide for deals outside of their sweet spots. In the IT space, a lot of this is caused by the fact that cloud computing, outsourcing, and other innovations have made it cheaper and cheaper to build a company—you don’t necessarily need VC money anymore, certainly not at historic levels. At the same time, very capital intensive companies in energy and biotech are a lot riskier now that the necessary later stage capital that would be found in the debt and public markets is harder to come by.

The numbers are a little misleading in some other ways as well. Ever since the stock market started dropping, VCs, like many angel investors, have been distracted by low public valuations to the point that there have been several PIPEs (private investments in public equities) being done by traditional VCs. I worked on one over the summer that involved a very prominent VC firm. At the time I found it somewhat surprising. By the winter, this started to become commonplace. Imagine you invested in a company and brought it to a successful IPO a couple years ago at $9 a share. Within a year, the stock prices almost doubles, but since then has had a rapid decline, along with the stock markets generally. You know the company well, believe in its story, and still see a promising future for it, despite what the public markets are telling you. And now its trading below $0.50. In that case, when choosing between a company at fire sale prices you know and believe in, versus a promising but unproven startup asking for a similar valuation, where do you think you would put your money? These deals are not showing up in the numbers, so they understate the amount of money VCs are putting to work over all (although they don’t understate how much money is going to early stage startups.)

Another source of the downward numbers may be that companies (and their investors) are distracted by looking at ways government stimulus funds may be available to them. I know a number of entrepreneurs who are looking for non-dilutive government funding first, before ever approaching VCs. Whether much of this stimulus money will ever makes its way down to very early stage companies, however, remains to be seen.

As we enter spring hoping the sparse winter was an anomaly and not a sign of things to come, there have been some hopeful signs recently. First, VC exits may start to recover soon. There were actually a couple of IPOs recently, and I’m happy to report that, at least from our experiences at Foley Hoag, there has been a noticeable uptick in M&A activity. These all should eventually have trickle down effects for early stage financings, as VCs free up time and resources that can be diverted to new ventures. Second, being that it is spring, its also been business plan contest season. As in year’s past I’ve seen a number of interesting plans. This year however, I had the chance to be a mock judge for TiE Boston’s TyE program, which is for high school students (there was even a team of 8th and 9th graders). I can tell you that I was blown away by the ideas and business plans coming out of these high school students. As one of the VCs judging the panel with me said, if these kids are the future and there are similar kids across the country, I’m not worried at all about the long term future of the country and its economy.