Venture capitalists are glass-half-full kind of people. And as 2011 approaches, investors in privately-held companies have reason for some new-found optimism. A string of positive exits of venture-backed companies -- including EMC's proposed buyout of Isilon Systems for $2.25 billion and Salesforce.com's planned purchase of Heroku for up to $249 million -- have raised the spirits of Seattle area venture capitalists.

Adding to the enthusiasm is a belief among many venture capitalists that cloud computing and Web-based services represent a transformational shift in the high-tech business.

Jonathan Roberts of Ignition Partners in Bellevue certainly feels that way. He calls the rise of cloud computing the most significant development he's witnessed since the PC revolution.

"Whenever there's a big shift, there's a big opportunity," said Roberts. "So, I think it is a pretty exciting time in venture right now."

In Silicon Valley, the red hot valuations of companies such as Facebook, Twitter, Zynga and others has sparked chatter that yet another version of the dot-com bubble might be forming. That was highlighted in early December when Groupon -- the Chicago-based online group buying startup -- reportedly spurned a $6 billion buyout offer from Google.

Nonetheless, corporate titans like Google, Microsoft, Apple and Cisco have plenty of cash on their balance sheets and that's fueling some speculation that the M&A wave will continue in 2011.

"My sense is, at some point they are going to have to spend," said Madrona Venture Group's Greg Gottesman, spaking at the WTIA predictions dinner last month. "And this isn't millions -- it is tens of billions, hundreds of billions of dollars on the balance sheets of these tech companies. Ultimately, people say that companies could give larger dividends, and I just don't think tech companies like to do that. So, I think they are going to go and continue to buy things and that should be good for the market."

Gottesman

In fact, the market has already heated up. During the third quarter, 45 technology merger and acquisition deals were recorded. That represented the highest level of deal activity in the past two years, according to a PricewaterhouseCoopers report. Even more impressive, the aggregate deal value jumped nearly 200 percent to $27.5 billion.

But it's not an entirely warm and fuzzy picture for venture capitalists. The dollars invested in the asset class are declining, down 31 percent during the third quarter alone.

Furthermore, the market for initial public offerings remains tough. Just one Washington high-tech company, Bellevue-based Motricity, completed an IPO in 2010 and the prospects for others to join the IPO party look rather bleak at this moment.

The lack of IPOs is driving venture capital returns in a negative direction. According to the Cambridge Associates U.S. Venture Capital Index, returns declined across most time horizons at the end of the second quarter. Ten-year returns -- the most widely watched metric in the venture business -- were down 4.2 percent at the end of June.

Mark Heesen, president of the National Venture Capital Association, issued this warning last month.

"The venture industry will likely see several more quarters of declining performance overall until distributions to limited partners begin to flow more readily in the coming year," he said.

Faced with slumping returns, venture capitalists are struggling to raise new capital. Neal Hansch, a principal at Rustic Canyon Partners, a Santa Monica, California venture capital firm, sees that continuing in 2011.

"Apart from a few highly visible exceptions, firms are generally still being relatively cautious in deploying capital and this is reflected in the gross investment numbers over the last few quarters," said Hansch. "I think we’ll also see 2011 total dollars invested to remain relatively flat with 2010."

[Flickr photo via Jenny Downing]