Venture funding continues its slide

Network start-ups are bearing the largest brunt of the continued drop in overall venture capital investing, according to a new survey.

          Network start-ups are bearing the largest brunt of the continued drop in overall venture capital investing, according to a new survey.

          The $US4.7 billion invested in 423 network companies was off 35% from the $US7.3 billion put into 527 companies in the first quarter and accounted for nearly the entire decline in venture capital investments for the quarter across all industries. The funding total represented the lowest amount since the first quarter of 1999 and the number of companies invested in was the fewest since the fourth quarter of 1998.

          These findings are part of a special analysis of the PricewaterhouseCoopers and VentureOne Money Tree survey conducted exclusively for Network World.

          "This is a normal contraction after a very, very hot period," says Tracy Lefteroff, global managing partner of the Venture Capital Practice at PricewaterhouseCoopers. "We are still above historical levels. The companies that survive will be strong and will be a solid base for the next step of growth going forward."

          Funding is decreasing, as venture capitalists -- bruised or worse as a result of the internet and telecom busts -- take more time to evaluate the business plans and revenue potential of start-ups.

          The falloff in network industry funding hit all sectors, including business services, software, hardware. The most dramatic investment hit was taken in fiber optics/photonics, where investment plummeted by $US800 million from the previous quarter.

          Still, observers are optimistic about the industry turning around.

          "Fibre optics and photonics, those areas are still very positive and a lot of people still look to that as the future of the whole communications and networking section," Lefteroff says. "In the short term we are reaching saturation, but in the long term venture capitalists think this is an area where there will be a lot of big winners. A lot of long-distance carriers need to overhaul fairly antiquated systems and it will be the suppliers of those products that are going to benefit in the long term."

          Despite optimism over long-term prospects, venture capitalists are changing the way they invest.

          Not only are VCs investing in fewer companies, but the size of those investments are smaller. Whereas companies in recent years have typically collected two or three rounds of funding before going public or getting bought, the survey identified several that were on their fifth or even six round as VCs looked to pay for actual performance. The number of seed and first-round deals was down about 50% from the first to second quarter.

          The biggest deal of the quarter was $US115 million to Sanrise, which provides managed data storage services. The next nine largest deals were all below $US80 million, a significant drop from last quarter when there were nine deals worth $US100 million or more.

          The numbers for Q2 were way off from those in the comparable quarter last year both in terms of investment ($US18.7 billion vs. $US4.7 billion, nearly four times less) and number of companies funded (1,131 vs. 423, almost three times fewer). Declines are likely to continue into the third quarter, according to Lefteroff.

          "It will be flat-to-a-down quarter; I don't see the activity picking up until the first quarter of next year."

          But overall for the year, investing is forecast to be above historical norms represented in 1998, before the tech investing boom of 1999 and 2000.

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