Nov. 20, 2003 — Caution continued to dictate small tech venture investment in the third quarter, with VCs favoring expansion-stage companies — trends that have dominated the general U.S. landscape for the past few quarters. 

Small tech’s share of venture capital increased slightly, gathering 6.2 percent of the $4.2 billion deployed, compared to 5.6 percent in the second quarter, according to Small Times’ analysis of the most recent MoneyTree Survey by PricewaterhouseCoopers, Thomson Venture Economics and the National Venture Capital Association.

NVCA President Mark Heesen said the cautious environment is “exactly what we want to see right now.” Investors are concentrating on the areas they know best rather than flirting with startups outside their areas of expertise, he said. 

Investors put $261 million into small tech companies in 27 deals in the third quarter, up slightly from the previous quarter’s $242 million in 23 deals. Consistent with recent quarters, the biotechnology industry garnered the most small tech dollars and deals, netting $103 million in nine deals, or 33 percent of the quarter’s small tech deal volume. Most of the small tech/biotech companies that received funds either create or use proprietary microarray or microfluidics technology.

Breaking it down geographically, California topped the list, with 10 deals worth $145.4 million, or 37 percent of deal volume and 56 percent of small tech dollars deployed. Massachusetts was second, with four deals accounting for $34 million; followed by Arizona, with three deals worth $12.4 million.

Gathering the largest amounts of the quarter were:

• Renovis Inc., a South San Francisco, Calif., drug developer that uses custom microarray technology, raising $45 million in expansion stage funding; and
• Alien Technology Corp. of Morgan Hill, Calif., which uses a self-assembly process to make RFID (wireless identification) products, raising $38 million in a late-stage round.

Entrepreneurs also negotiated some better terms from their venture backers, at least in the San Francisco Bay Area, according to Trends in Legal Terms in Venture Financing, a quarterly survey conducted by Fenwick & West LLP.

Small tech investors focused on expansion-stage deals, deploying $161 million in 17 deals, up from $60 million in eight expansion stage deals the previous quarter (when late-stage deals snared the lion’s share of funding dollars.) In the overall U.S. venture market, expansion-stage companies snared 55 percent of venture dollars and accounted for about half of the deals. These numbers appear consistent with Heesen’s observation that investors are concentrating on their specialties.

While small tech’s solid performance appear to bode well for small tech IPOs (Renovis recently filed for one), Heesen cautioned that the situation is still tenuous. “We cannot by any means declare victory here,” he said. The current crop of IPOs must contribute toward building credibility, he said. On the flip side, “a few dogs could spook investors.”

As a result, many are playing wait-and-see. “An awful lot of companies are still sitting there but don’t think this is the most opportune time,” Heesen said. The success or failure of those that go public in the next six months will dictate whether the necessary appetite exists among retail investors to open a new IPO window — and to keep it open.