Venture funding slows for net start-ups

Venture capital investments in network start-ups are coming back down to earth, but it appears they may be in for a soft landing. Industry watchers predict venture capital activity in areas such as fiber optics, wireless and broadband services will level off at a rate much higher than historical norms.

Despite three steadily declining quarters, the year 2000 was a record breaker for venture capital investment in network companies, according to a recent survey. Altogether, the venture capital community pumped $52.8 billion into start-ups developing network technologies and services.

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The year 2000 total reflects an 82% increase over 1999. That year, investments topped $29 billion, which was the previous record.

Network start-ups continue to get the majority of overall venture capital funding. Total investment in all industries was $68.8 billion in 2000, with more than three-quarters of that funding going to network companies.

These figures come from a special analysis of PricewaterhouseCoopers' MoneyTree Survey in partnership with VentureOne conducted exclusively for Network World.

"The outlook for 2001 is fairly positive," says Tracy Lefteroff, global managing partner of the venture capital practice of PricewaterhouseCoopers. "The venture funds still have a lot of money. The dollars are reaching a plateau, but at a higher level than in 1999 or previous years."

In the fourth quarter, investments in venture-backed network companies dropped 20% to $10.13 billion. This compares to a total investment of $12.65 billion in the third quarter and $14.87 billion in the second quarter.

The largest amount of venture capital activity ever recorded for network companies was in the first quarter of 2000, which topped $15.1 billion.

Altogether, 626 network start-ups received funding in the fourth quarter, down from 679 recipients in the third quarter and 849 in the second. The average deal size for the fourth quarter was $16 million, down from $18.6 million in the previous quarter but holding steady with the deals seen in late 1999 and early 2000.

Kirk Walden, national director of venture capital research at PricewaterhouseCoopers, says a significant amount of the deals consummated in the fourth quarter were early-stage investments, which he sees as a sign that the venture capital markets will remain strong in 2001 and beyond.

"With $10 billion available to network start-ups, who's going to go wanting?" Walden asks. "We saw more deals in the fourth quarter of 2000 than we saw in all of 1998. There's nothing wrong with this picture."

Indeed, the 10 largest venture capital deals of the quarter all involved network companies. Leading the pack was Calient Networks, a photonic switching system start-up that received $195 million, and Pihana Pacific, a secure Internet exchange provider that received $190 million.

Among the hottest network start-ups were fiber-optic component manufacturers, wireless service providers and makers of carrier-grade hardware.

The survey shows a marked decline in investment in application service providers and developers of enterprise software applications, but niches such as storage and security remain strong.

With the number and size of deals declining, venture capitalists are exercising more caution and exerting more control over the start-ups they invest in.

"The number of companies wanting funding is as high now as it was six months ago, but the number of deals getting funded is down substantially. So the bar is somewhat higher," says Cliff Higgerson, a partner at ComVentures, a Palo Alto venture capital firm specializing in network start-ups.

"In the past two years, a lot of marginal deals got funded as well as good deals. Now mainly the good deals will get funded," he says.

Venture funding slows for net start-ups

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