Venture capital moving to the sidelines?

Reuters’ economists may have reason to move their already-pessimistic projections further downward.  Yesterday afternoon, a study conducted jointly by Thompson Reuters and Price Waterhouse Cooper shows that venture capital investment dropped 7% in the third quarter, a harbinger of higher unemployment and economic decline:

Venture capitalists poured less money into U.S. startups in the third quarter and split this among more companies, signaling that investors are trying to be more economical with their funds.

According to a study set to be released Friday, startup investments declined 7 percent to $4.8 billion in the July-September period, compared with $5.2 billion invested during the same three-month period in 2009. A total of 780 startups received funding during the quarter — 9 percent more than the 716 companies that took slices of the investment pie last year.

The study, which was conducted by PriceWaterhouseCoopers and the National Venture Capital Association based on data from Thomson Reuters, said that much of the decline stemmed from a drop in large investments in clean technology. Funding in clean-tech startups, which include alternative energy, recycling, conservation and power supply companies, has been mercurial lately. It fell every quarter last year compared with the previous year, but has been climbing this year — until the third quarter.

The future outlook from the third quarter last year looked more promising than it does now.  Last year, investors expected a normal recovery, albeit perhaps somewhat slower than previous recoveries.  Investment went up in Q3 and Q4 last year in preparation for an expansion that has never arrived.

Now, that future looks significantly more bleak than it did a year ago, as the Reuters projections this week outlined.  Not only has the recovery not been normal, economists now don’t expect it at all in 2011, either.  Thanks to a massive amount of uncertainty introduced by regulation passed by Democrats this year in both ObamaCare and the Wall Street regulation bill — as well as the Democrats’ decision to postpone their tax-rate decisions — investors are getting a lot more cautious about their money, especially on the venture side, where the risk/reward ratios are much less clear than in the last recovery in 2003.

Look at where money did and did not go.  Expansion and later stages of development got more money, but start-ups in the “seed stage” saw a decline in funding of 11%.  Venture capital simply won’t fund much risk in an environment where capital-gains taxes are expected to increase and income tax rates are already scheduled to rise at the end of the year.  Money will go instead into proven enterprises, or more likely into shelters where they don’t provide any economic growth.  And ironically, that means that Barack Obama’s pet “clean” projects will be hardest hit, as reported by Rachel Metz at AP.

If venture capital continues to retreat, we may see another recession rather than the anemic growth predicted by Reuters this week.