Deals & More

Venture capitalists have tightened the screws on entrepreneurs, scooping up much larger chunks of ownership of companies in return for investments.

During the second quarter of the year, VCs pushed company values down 46 percent of the time when they invested, when those values are compared to the value of the company’s previous round. That valuation is used to determine how many shares VCs get from the company in return for their money. The lower the value, the more ownership VCs get, and the less is left for entrepreneurs. The “value” is negotiated between the VCs and entrepreneurs at the time of the deal.

It is the blood sport that makes up Silicon Valley.

The latest data comes for a survey by Silicon Valley venture capital firm Fenwick & West. The data shows that the percentage of down rounds remained the same as during the first quarter. The only difference is that more deals were actually up during the second quarter (32 percent) than they were during the first quarter (25 percent). But the past two quarters are the only quarters since 2003 — after the big Internet bubble burst — in which down rounds have exceeded up rounds.

These so called “down rounds,” which refers to when a company is valued lower than it was during its previous fundraising round, usually only happen when a company is no longer showing the same promise as it was before. But in years like this — a time of significant economic recession, and depressed stock market — there’s a double whammy that hits, and even well performing companies get hammered by their investors.

The first whammy is that VCs are so busy trying to shore up their existing investments that they devote less time and money to new investments. As cash is conserved, it means there’s less supply, giving the VCs an upper hand when negotiating new deals with entrepreneurs. But second, the VC firms themselves are raising less cash from their own investors, meaning that they are slowing down their investment pace — which results in still more cash being taken away from supply.

Barry Kramer, a Fenwick lawyer responsible for the study, said that if the Nasdaq continues to improve, valuations will get better. A more robust stock market means that large companies such as Intel, Yahoo, Oracle, Google and Cisco will be more ready to start acquiring companies. That gives VCs more liquidity — which in turn frees up their cash and their time. That in turn would result in more generous deal terms.

Some perspective: The survey, which was first started in 2002, shows that down rounds made up 73 percent of all deals in the first quarter of 2003, which is the highest level on record. That number gradually fell over subsequent quarters, to 56 percent in the second quarter of 2003, and to 53 percent in the third quarter of that year.

The latest results, for the second quarter of this year, also revealed the following:

• The average price decrease of 6% for companies receiving venture capital in 2Q09 compared to such companies’ prior financing round. This was a slight decline from 1Q09, when the Barometer registered a decrease of 3%.
• There were 67 acquisitions of venture-backed companies in the U.S. in 2Q09, for a total of $2.6 billion, a decline from 70 transactions totaling $3.4 billion in 1Q09 and a significant decline from the 89 transactions totaling $6.5 billion in 2Q09. This was the lowest dollar volume of acquisition transactions since 1999.
• Much more here.

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