By Sean Wolfe

Venture capital poured into United States-based companies at record levels in 2006, with the most dollars and deal flow since 2001.

That’s the latest from the Quarterly Venture Capital Report released by Ernst & Young LLP and Dow Jones VentureOne on Monday, which tracked $25.75 billion in capital deployed, up 8 percent over 2005 levels. Deal count was not so robust, with 2,454 deals done, up 1 percent from the prior year.

That was somewhat at odds with the numbers that appeared in the rival MoneyTree survey from PricewaterhouseCoopers, the National Venture Capital Association, and Thomson Venture Economics. That report showed a similar amount of capital, $25.5 billion, up 12 percent from 2005, deployed across a landscape of 3,416 deals, for a 10 percent increase.

While differences in measurement explain the disparities in the two reports, they do agree on the big picture. Namely, the venture community, having taken its lumps during the bubble years, has adapted by diversifying its bets into other industry segments and is holding onto portfolio companies longer, nurturing them along the path to positive exits.

Tracy Lefteroff, global managing partner at PricewaterhouseCoopers, said he doesn’t see any new bubble in the offing.

“VCs have raised a fair amount of money, and they’re trying to be as cautious and responsible as they can in deploying that capital,” he said. “I think the bubble years are still fresh in everyone’s mind.

“They’re not overpaying for deals yet, and not shoving money out the door like they were either,” he added. “The barriers to what gets funded are still relatively high, and I believe that environment is not conducive to producing a bubble.”

Sector Preferences

VCs showed increasing diversity with their sector bets for the year, setting new records across a number of categories. The software sector continued to command the lion’s share of VC rounds, with $4.9 billion, up 3 percent for the year.

Software was followed by biotechnology with $4.5 billion, up 17 percent for the same period. That was followed by the medical device sector, which continued its multi-year tear, drawing a record $2.6 billion, up 24 percent from 2005, the highest amount ever.

Alternative energy showed the biggest gains, fueled by multiple multi-million dollar bets on solar energy and ethanol. That interest was reflected in the MoneyTree report’s industrial and energy category, which saw $1.7 billion allocated, up 108 percent from 2005.

The previously sleepy electronics and instrumentation sector also racked up impressive gains, with $681 million in funding, the highest amount dedicated to the sector since 2000, up 76 percent from 2005 levels.

Fueled in part by Web 2.0, and the emergence of the mobile device as a media carrier, the media and entertainment sector proved that content is the once-and-future king. That sector saw $1.6 billion in new funding, up 54 percent from 2005, the most since 2001.

The MoneyTree survey also broke out investments it considers Internet-specific. That category showed significant growth, with $3.9 billion deployed in that sub-sector, up 24 percent from 2005. Overall deal flow for these investments rose to 644 deals, up 31 percent.

Round Sizes Grow

With exits—typically through mergers and acquisitions—taking longer, round sizes upticked in 2006. Overall median round size hit $7 million, up from $6.5 million in 2005, according to the VentureOne report.

It’s the highest median round size for any year, save 2000, when it peaked at $8.80 million. Restart rounds showed the greatest change, with the median round size in that category rising to $9 million, up 28 percent from a year ago.

Seed rounds also rose to $0.9 million, up 12 percent from 2005. Less significantly, second rounds rose 6 percent, from $8 million in 2005, to $8.5 million in 2006. Later-stage medians remained flat year-to-year at $10 million.

It’s the second year in a row in which investors focused more than a third of their activity on early-stage financings, with seed- and first-round deals making up 36 percent of the deal flow in 2006. About the same concentration of deal flow went to later-stage deals.

Joseph Muscat, Americas director of the Ernst & Young Venture Capital Advisory Group, said VCs are taking a measured approach between late- and early-stage investing, betting big on later-stage rounds without neglecting the seed corn of early-stage investing.

Americas

He also sees some successful IPOs and renewed competition between U.S. and overseas exchanges for companies helping to boost exit valuations.

U.S.“The expanding opportunities for venture-backed companies to achieve liquidity through an initial public offering, merger, or acquisition are having an impact,” he said. “It was a relatively strong year for these transactions, with investors recognizing the need to support their companies for as long as six years before they can achieve a successful exit.”