The last 12 or so months have been challenging for both startups and VCs. Fundraising has been tougher than in any other time in living memory (in this industry we tend to have short memories).

New funds have been few and far between (more about that in an upcoming blog entry) and new companies have had an exceedingly hard time getting financing as VCs have been forced to allocate an increasing portion of the funds for sustaining their existing investments. Mainly fresh funds and funds with deep pockets (and willing LPs) have been able to really look at new investments.

As a result of all this, there were a lot of inside rounds and down rounds in late 2008 and half-way through 2009.

Good news, did you say?

The latest data from several sources indicate that we might have turned a corner now.

But before we get to the good news, a short pop quiz. When was the last quarter with less US VC deals dollar wise than Q1/2009? How about deal amount wise? Answers towards the end of this post.

The good news is that we have rebounded quite a bit – in the third quarter there was about 50 % more money flowing into investments than in Q1 (even though the number of rounds stayed on almost the same low level).

Upside down, inside out

From the entrepreneurs’ perspective, there are other good news, too: the number of up rounds actually exceeded the number of down rounds, for the first time in 2009. The balance is still fairly close, with 41 % up rounds, 36 % down rounds, and 23 % flat rounds.

The development of up and down rounds. Compiled from Fenwick & West data.

While this is certainly a good direction, there is no reason to pop champagne corks quite yet: in Q3/08 there were 72 % of up rounds. The number of flat rounds is also large, at least compared to previous years. Flat rounds seem to suggest there is still lingering hesitation: while companies are worth further investment, there does not seem to be a good idea of how to value them. A flat round maybe the compromise that both the VC and the other owners can live with.

There is another encouraging sign: inside rounds are also down. There were 33 % of inside rounds (with no new investors) in Q3 compared with a worryingly high 42 % in Q2. Companies are clearly better able to attract new investors, which is a good thing.

A Sentimental Journey

When we overlay the deal volume data and the up-down data over the last several quarters, we can see that things are indeed up but not nearly on the same level as in 2007 or 2008.

Sentiment (in this case, defined by company valuation development) seems to correlate fairly well with overall investment activity. The more money is being invested, the more up rounds there are. This certainly makes sense by and large, but perhaps breaks in this pattern (which started to happen in 2008) can give clues about upcoming market shifts.

Answers and Perspective

OK, now the answers. The last quarter with less money in VC deals than Q1/2009 was Q1/1997. If we look at the number of deals, the answer is Q3/1996.

In fact, the full picture from 1995 to 2009 is pretty sobering.

While we may not wish to return to the irrational exuberance of the 1999-2001 period, there is still a fair amount of room for growth.

Sayeth Karl Kraus

We tend to talk a lot about sentiment in this industry. A good point to remember, however, is the famous quote by the Austrian wit and contrarian thinker Karl Kraus: “Sentimental irony is a dog that bays at the moon while pissing on graves.”