I’m hearing a lot of rumblings from local Waterloo startups (I loathe the term entrepreneur) about the sorry state of Canadian VC. Originally I brushed it off as mass hysteria and felt good about it. Supporting my theory, at a recent WatStart event, Marc Gingras of Tungle took issue with the idea that funding was drying up and suggested startups just weren’t talking to the right people.

Yet I hear rumblings that some VCs are having trouble raising new funds. Also in the fear mongering camp is Bob Ford, a former CEO of mine. He was quoted recently in the Ottawa Business Journal with this happy news:

“There’s just no big money in venture capital in Canada anymore. There are really very few funds that are doing well at all, and although there are exceptions, overall it’s pretty tough right now,” said Bob Ford, a partner in Gowlings’ business law department working from its Kanata technology law office.

From my experience, Bob was never really what you’d call an optimist but he’s not a pessimist either. His law experience makes him pretty factual though he does know how to deliver a message. So what’s going on people?

This week, the Q3 2007 stats (pdf) were out by the NVCA, PwC and Thomson Financial. VentureBeat did a great job summarizing the stats in their post. But I’ll take a crack at the numbers from my perspective.

First the good news, investment continues to be steady and according to a statement in August by the NVCA, investment is at the highest level since 2001. Average deal size is looking good too. So why all the hub bub, bub?
VC investment in Q3 07

As you can see, all is well from an activity basis and I bet the lawyers and accountants are doing very well thanks to transaction volume. However it would appear that perhaps at least some of the rumblings from startups that I’m hearing is substantiated by the fact that money is flowing to follow-on investments and seed isn’t getting the dollars those deals are chasing.

Money Going to Late Stage Investment

More good news, at least for me, a software guy, is that VCs remain focussed on Software and BioTech pouring over a billion into each of those categories.

Investors focussed on Biotech and Software

The news is even better if you’re an Internet company where Q3 saw an investment of $1.1 billion, an impressive 17% climb over Q2. Clean Tech is also alive and kickin’ it hard, thanks Al Gore!
Internet and CleanTech on the rise

So not too shabby but all is not well for the venture funds themselves. The NVCA reports that fund raising by the VCs has slowed to only 79% of the volumes for the same period last year.

Fundraising by VCs

Seems consistent with what the rumors that VCs are having trouble raising follow-up funds. So everything is ok then? But then I get this funny smell from the NVCA press release:

“We expect the number of venture capital firms raising funds to remain very stable and perhaps even decline during the next year as these venture capitalists focus on deploying the dollars that have recently been raised,” said Mark Heesen, president of the NVCA. “The high percentage of early and balanced stage funds raised suggests a continued venture capital focus on growing young, start-up companies from the ground up.”

Hmmmn, that’s not what your own stats seem to be showing — early stage investment growth is slowing. Are VCs retrenching on early stage investment? Ruh-oh that is a pretty steep downward curve forming there in Q3

24% of investment dollars in Q3 are First Sequence

I’ll toss another interesting nugget into this little conspiracy theory that’s forming. In the same post Venture Beat reports that mediocre results have stalled Sequel Venture Partners of Boulder, Colorado new fund raising as “yet another” example of the pain VCs are feeling. So no returns, no investment? Seems like we’ll all feel that one and probably rightly so.

So what’s wrong in the crazy world of venture capital and startups? I’ve heard and participated in a couple of discussions/theories. Obviously the drying up of labor sponsored funds in Canada can account for at least some of the hardship non-obvious/riskier startup deals are facing. But that seems too easy and doesn’t account for the MoneyTree data which is US only.

Are yesterday’s methods and models to blame? Things like Amazon’s EC2 and S3 utility computing infrastructure just didn’t exist in the mainstream 12 months ago and obviously are game changing. Five years ago I started a SaaS company in the finance space. It was tough, if not impossible to stretch the VC Excel due-dili jock’s enterprise software model to fit and allow for the infrastructure spend and recurring revenue models associated with launching a SaaS operation. Facebook’s API/platform (and now LinkedIn and mySpace) though unproven from a revenue perspective is also equally difficult to cram into a spreadsheet.

If startups and developers are flocking towards Web 2.0, 3.0 and heaven help us 4.0 plays, do they fit effectively into financial models and investment criteria established as recently as last year? Are entrepreneurs (there I said it) to blame? Are we too optimistic (that’s code for unrealistic) clinging to valuations like Geni’s $100MM?

So do we need to start fresh yet again? Have things changed that much? Is sub-prime hysteria and the specter of a US recession causing VCs to retrench for the long haul?

We’re in this together people, we better figure it out.