Vonage Got The Call: Received The Largest Later-Stage Funding

Venture Capital Firms Putting More Big Bucks Into Late-Stage Rounds

July 27, 2005

By Brian Deagon

U.S. venture capital investments rose 18% last quarter from the year-ago quarter to $5.8 billion, putting the field on track for a solid year.

So says the quarterly MoneyTree venture survey released Monday by PricewaterhouseCoopers, the National Venture Capital Association and Thomson Venture Economics.

A marked increase in later-stage funding propped up last quarter's tally. Later-stage deals, typically funding that comes after a third funding round, hit $2.4 billion last quarter, a four-year high.

That shows venture capital firms are financing companies longer, which is both a good and bad indicator. It's good in that it shows continued faith by the VC firms. It's bad because it shows weakness in initial public offerings.

Some IPOs Pulled
Only 10 venture-backed firms did IPOs last quarter, and only 48 were completed in total. That's down from 27 and 82 in second-quarter 2004, says the NVCA.

Venture capital firms rely on a healthy IPO market to cash out their investments. It's not the only route — mergers and acquisitions are the biggest cash-out avenue — but it's often the most preferred. A successful IPO can lead to the biggest investment gains.

Through June 30, U.S. market logged 91 IPOs. That's down 15% from the first half of 2004, though still ahead of 2001 through 2003.

The stock market has put lower-than-expected valuations on some pending IPO companies, thwarting venture firms' efforts to take companies public. Several high-profile IPOs were pulled this year, such as Boise Cascade's, or came in at prices well below the initial asking price, such as Warner Music Group's.

When institutional investors show a lack of interest in buying IPO shares, the companies and their venture backers are forced to either cut their asking price or postpone the IPO. Some venture-backed firms are choosing to postpone, hoping they'll get a better price later.

"VC firms are saying they're not willing to sell at a price they believe is undervalued," said Tracy Lefteroff, managing partner of the Venture Capital & Private Equity Practice of PricewaterhouseCoopers.

So, more venture firms are choosing to do later-stage financing.

For many startups, investment follows a similar pattern. First comes seed money from company principals and other individual investors. Then comes early-stage VC funding of one, two or three rounds. After that, it can be a matter of time before the startup is bought or goes public.

In the first half of the year, later-stage funding amounted to 41% of all VC dollars, a 10-year high and well above the 2004 average of 34%, says MoneyTree. Six of the 10 largest venture deals in the second quarter were later stage.

Vonage Got The Call
Vonage received the largest later-stage deal, getting $200 million and lifting its total VC investment to $408 million. The company provides Internet-based telephone service, known as voice over Internet protocol. It has 800,000 VoIP subscribers, up from 500,000 in March.

Analysts believe Vonage could have gone public rather than gone back to the VCs. The company doesn't comment on such matters.

"Later-stage financing is a reaction to an inconsistent IPO market," said Shanda Bahles, a partner at El Dorado Ventures. "Vonage could have gone public."

Still-private companies with solid VC funding and a track record in business might be drawing more interest from private equity firms. Traditionally, private equity firms use their billions to buy and rebuild struggling older firms. They tend to avoid the startups that VCs fund.

But private-equity giant Kohlberg Kravis Roberts was the lead investor in a recent later-stage round of funding secured by Jazz Pharmaceuticals, which is developing neurological and psychiatric products. It received $100 million in the second quarter and access to another $150 million if needed.

In the second quarter, investors spent $6.8 billion buying venture-backed companies. That's up 14% from a year ago, says VentureOne.

"These firms have attracted the attention of traditional buyout funds," said Lefteroff.

It's hard to say whether private equity firms will start competing more with venture firms.

"But with later-stage deals, we are seeing some blurring of lines," said Bahles.

Private equity firms might be doing what venture firms won't.

"Some of these companies are not growing at the rate venture firms want," said Matt McIlwain, managing director at Madrona Venture Group. "Private equity firms may be more willing to take a company that's been around five years, hold onto it longer and sell it later."