Is Southern California's Venture Capital Downturn Finally Coming to an End?
March 15, 2004

By Ketaki Sood, Larta Institute Research Economist

Southern California's Venture Capital Activity Stabilizes

Venture capital investment declined in Southern California in 2003 as both the dollar amount ($1.7 billion) and the number of venture capital investments (242) fell from 2002 levels. These figures, however, mark the smallest year-to-year decline in venture capital in Southern California since the dot-com bust in 2000, indicating that the downturn in venture capital activity in the region might finally be coming to an end.

The amount of venture capital invested in Southern California declined 21.9% between 2002 and 2003. The decline in the number of venture capital investments in Southern California was nominal for the year, dropping a mere 2% from 2002 levels. This decline, however, paled in comparison to the precipitous drop in venture capital activity the region experienced since the dot-com bust. Venture capital activity in Southern California seems to be returning to more sustainable levels.

Percentage Change in the Number and Amount of VC Invested in So Cal, 1998-2003

Source: PwC/VE/NVCA MoneyTree data aggregated by Larta Insitute
Copyright 2004 by Larta Institute - connecting people to drive innovation

Quarterly investing in Southern California ended on an up note as well. While there has been a decline in both the amount of venture capital invested and number of venture capital investments between quarter three and quarter four of 2003, venture capital activity in the region is still up from the first quarter of 2003. $420 million was invested in Southern California in the fourth quarter of 2003, up 75% from the $240 million invested in the first quarter of 2003. The number of venture capital investments in the region stood at 59 in the fourth quarter of 2003, outpacing the 47 investments made in the first quarter of 2003. Southern California's venture capital industry seems to be regaining its equilibrium, with more of a balance between risk and investment.

Caution Despite Revival

The revival in Southern California's venture capital industry is evident, but like everything, upswings don't last forever. Today's venture capital investment pace is being driven by a variety of factors, including the recovery of the IPO and technology markets, increased technology spending, the supply of quality management and technical talent, large amounts of available capital, and most importantly, a more positive outlook. Some of these factors are cyclical, with short-term implications, and venture capitalists are therefore quick to point out that there is caution despite revival.

As Bob Holmen, Partner at Miramar Venture Partners argues, "Venture capital has a much longer investment horizon than other forms of investing. The focus is on building great companies over five to seven years. Therefore, if the venture capital industry sticks to its fundamentals, there should be no reaction to the current environment (be it positive or negative) in funding and building companies. We shouldn't allow ourselves to invest into a short-term upswing or slow our investment pace during a short-term downswing."

What Companies Seeking Venture Funding in the Current Environment Need to Know

The venture capital industry is coming off of four tough years, and for entrepreneurs, the current environment is analogous to the late 1980s and early 1990s, and not to the dot-com bubble. As a result companies have to ensure that their product meets a real need in the market place.

Adds Brad Jones, Founding Partner of Redpoint Ventures, " Entrepreneurs have to make sure that their business opportunity is large enough and that they have a good qualified team of people. They need to be realistic about valuations, and how long it takes and how much money it takes to bring a product to market. If they can do all of this, venture capitalists will definitely show interest in them."

Concurs Greg Martin, Principal at Redpoint, "My message to entrepreneurs is quite simple. There are opportunities in today's environment to build successful companies. Find markets where innovation provides significant value, create a defensible solution, build a team that can execute, and develop a plan that optimizes capital and maximizes return."

Looking Ahead

The venture capital industry in Southern California is far from the lofty heights it reached during the dot-com boom. The downward spiral in the industry, however, appears to have come to an end. And even though venture capitalists remain cautiously optimistic, technological change continues to create opportunity for new entrants. And rewards are abound for companies with strong management teams that optimize return on investment by providing unique solutions to market needs.

Read a detailed overview of Southern California's venture capital industry in Larta Institute's publication "The Sand Dollar Report 2004: An Analysis of Venture Investing in Southern California"

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