Network start-ups hurt as venture capital dries up

IPO dry spell contributes to lowest investment total in a decade

Venture capital investment in network technology companies has hit its lowest point in a decade.

Venture capital investment in network technology companies has hit its lowest point in a decade, and one expert says it might get worse.

Investors are wary of investing in start-ups because they have poured millions of dollars into existing companies that have not yet provided liquidity in the form of IPOs or mergers and acquisitions, says Tracy Lefteroff, a global managing partner of Pricewaterhouse Coopers (PwC).  (View a slideshow of recent mergers and acquisitions.)

"I couldn't point to anything that's done really well [in the networking sector]. The whole space is suffering," Lefteroff says. "If [investors] don't see liquidity on the horizon it's going to be tough to justify funding a lot of new companies in this space."

Lefteroff predicts that the number of deals and dollar amounts will continue to drop.

A list of venture capital deals

Venture capitalists in the third quarter invested $2.07 billion in 328 networking companies, including makers of hardware, telecom products, network-related software and Internet-related technology, according to data provided to Network World by PwC and the National Venture Capital Association, authors of the quarterly MoneyTree Report. That's the lowest quarterly total since 1998's first quarter, when investments were just less than $2 billion. It's also the fewest number of deals in any quarter since 1996.

Investments soared during the dot-com boom, surpassing $15 billion in each quarter during 2000. Venture funding became much scarcer after the bubble burst, but investments generally remained steady at between $2.5 billion and $3 billion per quarter each of the past five years.

Third-quarter investments dropped almost a full billion compared with last year's third quarter, when 411 deals accounted for just more than $3 billion. The latest numbers also show a precipitous drop since this year's second quarter, when 408 deals totaled $2.75 billion.

The current economic crisis is clearly limiting the amounts of money available from venture capitalists. What's most worrying for young companies is that investors are being forced to continue pouring money in late-stage companies that have not yet been acquired or gone public, leaving less money for true start-ups. The top ten networking deals in the third quarter all went to late stage and expansion companies. The 11th biggest deal went to an early stage company, Jasper Wireless. You have to go all the way down to the 85th biggest deal to find one that went to a company in the start-up/seed phase — Schooner Information Technology, a data access company led by veterans of Sun Microsystems.

There were 34 start-up/seed venture deals in the networking space during the third quarter, about the same as the 36 deals in last year's third quarter. But the dollar amount dropped from $100 million for start-ups in the third quarter of 2007 to less than $80 million in the third quarter of 2008.

As Lefteroff notes, this is largely because later-stage companies aren't providing liquidity to investors. There were zero venture capital-backed IPOs in the second quarter of 2008 in all industries, the first time that's happened in 30 years. There were five IPOs in the third quarter, including both venture-backed and other companies, according to PwC. One networking vendor went public in the third quarter: Rackspace Hosting.  

By contrast, 43 venture capital-backed companies went public in the first half of 2007.

Going forward, investors are unlikely to put much money into hardware companies that need a lot of capital, such as those in the router, telecom or fiberoptics businesses, Lefteroff says. Storage and servers will likely suffer quite a bit as well. (Compare storage products.) Investors may be more likely to put money into software and services companies, because they require less capital, but Lefteroff did not sound confident about any portion of the network technology industry.

"There were fairly significant decreases this year both in deals and dollars, which I think is a trend we may see continue for a while, until we get some liquidity back into the market," he says, adding that venture capitalists will be "extremely cautious" about where they put their money the next couple years.

There was some good news this week for LinkedIn, a business-networking site that raised $22.7 million from investors, including SAP. 

Here's a look at the Top 10 networking venture deals from the third quarter, data courtesy of PricewaterhouseCoopers:

1. Company: Trilliant Redwood City, Calif.   Late Provides wireless network solutions for grid management applications. $40 million MissionPoint Capital Partners, Zouk Ventures

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2. Company: Mimix Broadband  Houston, Texas Late Manufactures semiconductors for the millimeter-wave market. $36 million First Capital Group Management, undisclosed venture firm.

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3. Company: 3Leaf Systems Santa Clara, Calif.   Late Develops systems software and virtualization technologies for the enterprise servers markets. $35 million Alloy Ventures, Intel Capital, LSI Logic Corporation, Storm Ventures LLC 

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4. Company: Mail.com, El Segundo, Calif. Expansion Provides consumers with Web-based e-mail services. $32.4 million Novel TMT Ventures, Quadrangle Group LLC, WI Harper Group 

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5. Company: Riya San Mateo, Calif. Expansion Operates a visual search engine under the name Like.com. $32.3 million Bay Partners, BlueRun Ventures, Crosslink Capital, Leapfrog Ventures, Menlo Ventures 

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6. Company: Vanu Cambridge, Mass.   Late Develops waveform software and design consulting services. $32,000,000 Charles River Ventures, Norwest Venture Partners,Tata Capital

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7. Company: Lightwire Allentown, Penn.   Expansion Develops interconnect solutions using CMOS optoelectronics. $30.9 million Anthelion Capital, Artiman Ventures, undisclosed firm 

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8. Company: Greenplum San Mateo, Calif.   Late Provides database solutions for businesses. $29.6 million Dawntreader Ventures, EDF Ventures, Meritech Capital Partners, Mission Ventures, Sierra Ventures

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9. Company: Palo Alto Networks Sunnyvale, Calif.   Expansion Develops enterprise network security solutions. $27 million Globespan Capital Partners, Greylock Partners, Lehman Brothers, Sequoia Capital

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10. Company: JumpTap   Cambridge, Mass. Late Provides end-to-end, carrier-branded mobile search solutions. $26 million AllianceBernstein L.P., General Catalyst Partners, Redpoint Ventures, Summerhill Partners, undisclosed firm, Valhalla Partners

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