September 30, 2005 Startup M&A Jumps 23% in Q3 Merger and acquisition activity heats up as companies seek to buy intellectual property to gain an edge. Merger and acquisition activity among startups cranked up 23 percent in the third quarter over the same period last year as companies sought to acquire intellectual property to boost their competitive advantage, experts said Friday. The pickup helped spur a 16 percent increase in venture capital investment in the quarter as VC firms looked to put money into companies that had a good chance of being bought. "The third quarter is looking incredible," said Eric Gebaide, the managing director of investment bank Innovation Advisors. The number of venture-backed M&A transactions increased to 530 during the third quarter, up 23 percent from 431 during the same period in 2004, according to projections by investment bank Jefferies Broadview. The number of deals greater than $20 million increased 22 percent but the median transaction size decreased as big tech companies picked up niche companies. "They're not trying to bulk up for bulking-up's sake," said Mr. Gebaide. "They're trying to get protectable and defensible intellectual property. Nobody feels greatly confident about the future." IT service companies saw a large jump in transaction activity, rising 50 percent during the first half of the year. Acquisitions in the service sector are considered to be a leading indicator of IT investment. Valuations in the sector went up 37.5 percent, according to Mr. Gebaide. "Smaller companies are getting bought at larger premiums," said Mr. Gebaide. Large companies are looking to go public while mid-size companies are looking for an extra round of venture financing, Mr. Gebaide said. "Boards and VCs are feeling better about continued funding--and it's giving them optimism to go into new deals," said Mark Zanoli, head of tech banking at JPMorgan.   2Q2004 3Q2004 4Q2004 1Q2005 2Q2005 3Q2005* Number of Transactions 430 431 434 477 487 530 Transactions Bigger than $20 million 91 76 86 84 114 120 *Projection based on data from July 1 - September 21     Venture Investment Up Venture capitalists invested $5.75 billion during the third quarter, a 16 percent increase over the $4.95 billion invested during the same period last year. The increase in investment may be the product of improved portfolio performance as venture firms start to have their companies bought. "VCs who were disciplined and active over the last couple of years could do very well," Mr. Zanoli said. "We've had the busiest quarter of our history," said Sanjay Subhedar, an investor with Storm Ventures, a VC firm founded in 2000. "We've done three deals in the quarter already and have four or five term sheets out. We find the quality of deals is very good, and much better than they've ever been," Mr. Subhedar added. Funding has historically slacked off during the third quarter, but preliminary investment figures collected by Red Herring suggest at least a 7 percent increase over the second-quarter investment total. Some 512 startups announced funding between July 1 and September 30, slightly down from the 514 that announced funding last year. The median deal weighed in at $8 million in the quarter, up from a $7-million median in 2004. "Valuations are creeping up and there's more competition," Mr. Subhedar said. "You really have to be on top of things. You don't have months to do due diligence." Warren Weiss, an investor with Foundation Capital, said his early-stage-focused firm has kept up a steady investment flow of one startup a month. He's seen increased competition among investors seeking to back Internet companies that target a wide customer base. "There almost is a consumer bubble," he said. "It's getting more money and attention from early-stage venture people. The limited partners are saying, 'Wow, where's the next Google? Where's the next Skype?'" Sector Breakdown Pharmaceutical startups in the third quarter collected the most venture cash, weighing in with $720 million, according to reports collected from Red Herring, VentureWire, and Private Equity Week. Much of the investment interest in this sector stems from positive acquisition trends in the healthcare space during the previous quarter. Six of the top 12 acquisitions from the second quarter were healthcare companies, according to numbers from VentureOne. Those six companies sold for a total of $1.35 billion. The communications and software sectors also posted a strong third quarter. VCs put in about $650 million into each market, perhaps in anticipation of increased IT spending by large businesses looking to replace the tech they bought during the boom.   Sector Funding in Millions Pharmaceuticals  $   720.3 Communications  $   649.4 Software  $   648.4 Wireless  $   587.4 Internet  $   525.2 Other  $   501.1 Biotechnology  $   441.8 Semiconductors  $   402.0 Medical Devices  $   231.2 Entertainment  $   199.7 Security  $   187.1 Networking  $   138.1 Storage  $    81.3 Healthcare  $    78.3 Optical Networking  $    69.7 Hardware  $    37.2 Automotive  $    37.0 RFID  $    32.0 Cleantech  $    24.0 Opensource  $    14.2 Nanotech  $    13.6   Article URL: Click here