VC funding slumps in Q1, but get ready for 'Instagram effect'

People looking for signs of a slowdown in tech funding could find ample evidence in the data for the first quarter. CB Insights, which tracks investments of venture capital firms and some big angel investors, reports that VCs plowed $5.9 billion into startups in Q1 -- a 22 percent drop from the last quarter of 2011 and the lowest amount since the second quarter of 2010.

But not so fast. That's not the sound of a bubble popping. Deal volume was huge in the first quarter, and lack of any mega-deals dampened the sheer dollar amount. (Yammer, the social network for businesses that in February raised $85 million, was the biggest deal of the quarter.) All told, VCs made a total of 785 investments in the quarter, the second most of the last nine quarters (see chart above).

What the report shows is that investors cut a ton of checks for smaller amounts, which makes sense given that the cost of starting a tech company continues to fall and startups are sprouting up all over the place. The number of deals is evidence that startup investing party is still going strong.

In addition, seed investing -- defined as investments of less than $1.5 million, or simply because a VC announces the deal as seed stage -- hit a record high. Almost one of every five deals were early stage seed investments, and even that figure is low since the this report doesn't include the many small investments made by individuals on their own or through AngelList.

Most of that money went going into Internet startups (see below), as health care deals sputtered and green tech deals were dried up almost completely.

Investments into mobile, which includes mobile apps, also got hit in the first quarter, falling 49 percent from the last quarter of 2011, as the chart below shows. But that was before Facebook plunked down $1 billion in cash and stock to buy Instagram, a deal that will likely drive up investments in all things mobile.

"The Instagram deal pushed mobile into the limelight in a big way," said Anand Sanwal, the CEO of CB Insights, which is why he expects to see an "Instragram effect" in the coming months.

The report also breaks down investment activity by cities and states. California, still the top of location for VC investments, saw a 26 percent drop in funding from last quarter. New York also saw a dip in funding, but deal activity remained strong. Massachusetts saw a falloff in both the number of deals and funding level. Washington state, meanwhile, was the only major area to see an increase in funding, by 41 percent, from the prior quarter.

You can check out the whole report here.