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Innovation Economy

Painful, but positive, changes for venture funding

By Scott Kirsner
Globe Columnist / July 19, 2009

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The universe of venture capital firms - and the amount of money those firms control - is shrinking.

That fact is going to affect the region’s innovation economy in positive and negative ways. But even the positive ways will be painful.

According to Michael Greeley, chairman of the New England Venture Capital Association, last year there were about 45 venture capital firms among NEVCA’s membership that he considered active, meaning they’d made more than three investments to help get new companies off the ground. Going forward, Greeley estimates the number of active firms in our region will drop to something like 20 to 25.

The National Venture Capital Association reported last week that venture capital firms brought in just $1.7 billion in new capital in the second quarter of 2009 (venture capital firms raise money from wealthy individuals, pension funds, and university endowments, and then dole it out to fledgling companies). That’s a precipitous plunge from $9.2 billion in the same quarter last year.

And several local venture capital firms, such as Prism VentureWorks in Needham and Oxford BioScience Partners in Boston, have put on hold their efforts to raise new money, while other firms, like Highland Capital Partners in Lexington, are aiming to collect smaller pools of capital than they have in the past.

“The immediate impact of all that will feel pretty negative,’’ admits Andy Payne, a serial entrepreneur who recently worked with Cambridge-based General Catalyst Partners to launch FanSnap.com, a site that helps consumers find tickets to concerts and sporting events. “There will be fewer guys at the venture capital firms, and fewer new projects that get funded.’’

But over the long term, Payne says, the impact will be “a net positive. Excess capital is distorting to the market and to individual companies.’’ Meaning: Too much venture capital money breeds too many start-ups chasing the same opportunity, and when a company gets too much funding, it has little incentive to act frugally. Also, Payne adds, start-ups that are flush with cash can afford to sell their products or services at a loss (or simply give it away), which can impede the healthy growth of its market.

Right now, things feel eerily quiet on the venture capital front, though venture capitalists continue to take meetings with entrepreneurs who are looking for money. Mike Troiano, a tech executive who is currently helping Crimson Hexagon Inc. raise money, told me last week that “if we got paid by the meeting, we’d be sitting pretty.’’ (Crimson Hexagon is a Cambridge start-up that helps companies track what consumers are saying about their products online.)

DACE Ventures, based in Waltham, made its most recent investment last August, though cofounder David Andonian says his fund still has enough money left to invest in three to five new companies.

“We’ve naturally raised the bar a little bit’’ in terms of the characteristics DACE wants to see in a prospective investment, Andonian says.

One unusual thing a few venture capital firms are doing these days is bargain-hunting: They’re buying stakes in start-up companies from other venture firms, at a deep discount. Todd Foley, a partner at Boston-based MPM Capital, which invests in life sciences companies, expects twice as many of these deals to happen in 2009 relative to last year. “The sellers are sometimes venture firms exiting the business,’’ Foley says.

Earlier this year, MPM bought the position that a New York venture capital firm, CW Group, had acquired in Surface Logix, a Brighton company developing drugs for cardiovascular and metabolic diseases. (MPM also put some additional money into the company’s $15 million funding round.)

“Surface Logix is a company that we had been watching for a while, but it was very expensive,’’ Foley says. “In this situation, we got a discounted toe-hold in what we think is a great company.’’

But biopharmaceutical companies just coming out of the starting gate, as well as clean-tech companies, could find it more of a challenge to raise money, since they require so much of it, says Dan Primack, an editor at large with Thomson Financial who keeps tabs on venture capital. That’s also true of technology companies trying to build a new piece of storage or telecommunications equipment, or a major infrastructure company like Akamai Technologies Inc., which sometimes need to raise $50 million or $100 million to reach profitability, get bought, or go public.

“Our region has been pretty dependent on those larger, more capital-intensive kinds of companies,’’ says Andonian. “But maybe, in a good way, what’s happening will shift some entrepreneurs more toward the very lucrative side of building more capital-efficient companies.’’

While the overall size of the venture capital cake is getting smaller, there is some good news locally on the venture capital front. Third Rock Ventures, which was founded just two years ago, oversees a $378 million fund and has so far started eight companies, including a protein engineering company called Denovo Therapeutics and a company targeting rare diseases called Edimer Pharmaceuticals. Third Rock Ventures cofounder Kevin Starr estimates that they will fund “another seven or eight over the next six to nine months.’’

TechStars Boston, a summer program designed to help first-time entrepreneurs start companies, will show off the first batch of nine companies that have been through the program this September. Each team gets an average of $15,000 to $18,000 of seed funding from TechStars. One start-up, Laura Fitton’s Oneforty, has already raised additional funding.

And Founders Collective is a Boston venture capital firm so new it does not yet have a website. But the partners, a crew of entrepreneurs and angel investors led by Eric Paley, Chris Dixon, and David Frankel, have already raised $30 million and made a handful of unannounced investments so far, all less than $1 million each. The Founders Collective fund could grow to $50 million over time.

“They’re going to be very active,’’ says Greeley, whose firm, Flybridge Capital Partners, has been housing Founders Collective until it finds an office of its own. “They could fund 60 or 80 companies over the next two years. There’s some real energy there, and I don’t think there’s another firm like them in town.’’

Scott Kirsner can be reached at kirsner@pobox.com.