Investors wary of networking start-ups

Venture capital funding for networking start-ups is hard to come by these days, because investors still taking a hit from the excesses of 1999 and 2000 have limited the amount they’re willing to spend on new companies in favor of later-stage players.

Networking investments “generally have not performed up to expectations,” says Tracy Lefteroff, global managing partner of Pricewaterhouse Coopers’ private equity and venture capital and life sciences industry services. “In the 1999 to 2000 timeframe, so much money was thrown at this sector, you kind of had an inundation of new technologies, devices and capacity. It’s taken a while for the Internet world to absorb that capacity in new products.”

Investments in networking companies – including hardware, telecom and Internet-related technology – reached a high of $67 billion in 2000 before dropping off dramatically. Investments have remained between $11 billion and $11.6 billion each year from 2004 to 2007, according to the PricewaterhouseCoopers MoneyTree Report.

The lion’s share of that money, more than $9 billion a year, is poured into expansion and later-stage companies. Even though the total networking investments rose slightly from 2006 to 2007, the amount invested in early stage and start-up companies dropped from $2 billion to $1.8 billion.

That means venture capitalists are carrying a heavy load of companies originally funded in the late '90s or early this decade, but haven’t been able to cash in on those investments to their hearts’ content. The longer those investments stay in their portfolio, the lower the rate of return will be, and at some point venture capitalists will start losing money, Lefteroff says.

“Until they get liquid on a lot of those portfolio companies, there’s no incentive for them to crank up additional amounts of money in the sector,” Lefteroff says. “It’s been a very tough sector for venture capitalists to make money in over the last five years.”

This trend will obviously make it harder for entrepreneurs to be successful with new companies developing networking technology.

“It affects the rate of new company formation,” Lefteroff says. “Unless you’ve got some killer idea, it’s tough to get funded in this space.”

Wireless and mobile applications are performing well, however, and Lefteroff expects interest in that technology to remain high.

“I think that’s going to continue, absolutely,” he says. “The hardware companies have done a great job making all these wonderful devices. Now the challenge in the industry is how do you push all the content out to these mobile devices?”

Social networking and Web 2.0 are getting a lot of attention from investors, but those technologies were not included in MoneyTree’s analysis of networking-related investments.

One wildcard that could affect future investments is the capital gains tax. Lefteroff says venture capitalists worry the current rate of 15% could be raised if a Democrat wins the presidency.

Nationwide, venture capitalists spent $29.4 billion in 2007, more than each of the previous five years.