How to judge the health of an industry? One VC firm’s analysis of the venture capital data (via PEHub) reveals a bigger decline in firms than previously thought.

While the NVCA data tells one story — the number of VC firms peaked in 2001 with 946 firms and in 2006 was at 798 (a 15 percent drop) — the firm, OVP, argues that simply looking at the number of VC firms in one year to another doesn’t say much about firms that are active in those years. Using that methodology, there’s been about a 50 percent drop from 2000 to 2006 in the number of active VC firms, from 1,156 to 597.

Pair that fact with the fact that fund size is increasing (average fund size in ‘06 was $200MM up from $100MM in 2000), and you can craft a picture along the following lines, explains the OVP:

“There were a gaggle of new funds of the bubble era under $100M. Most of them have died (see shake-out), with a few succeeding and increasing their scale. Since 2000, and particularly recently, there has been a flight to quality.

So, the second unwritten story of the bubble was not so much the billion dollar funds that cut themselves back, but the hordes of small funds that messed up the market by investing in the seventh company in a given space, failed, and then quietly went away.”