• United States

Start-ups scramble for venture dollars

May 10, 20046 mins

The number of venture capital deals involving network start-ups dropped to the lowest level in seven years during the first quarter. However, overall investment in these companies held steady, as venture firms concentrate their dollars on the start-ups that seem most likely to succeed.

Venture capital database

Browse through four quarters’ worth of data.

These are the findings of the quarterly MoneyTree survey, which is put together by PricewaterhouseCoopers, the National Venture Capital Association and Thomson Venture Economics. Network World receives a subset of the MoneyTree data that targets investments in network hardware, software and services start-ups.

The latest MoneyTree numbers identify 321 deals involving network start-ups that closed during the first quarter. The amount of deal-making is down 14.6% from the previous quarter. The last time so few investments were made in network start-ups was the third quarter of 1996. While the number of deals went down last quarter, the average size of the deals was up slightly. Deal size averaged $6.74 million in the first quarter, compared with $6.65 million in the fourth quarter.

The sharpest drop was in first-round financing. Venture firms invested seed money in 11 network start-ups – the lowest number since the MoneyTree Survey began in 1995. Until now, the lowest number was 39, in the first quarter of 1995.

“There’s a much greater emphasis on commercialization than there is on innovation,” says Kirk Walden, national director of venture capital research at PricewaterhouseCoopers. “Revenues, customers – that’s what VCs are interested in, as opposed to new ideas.”

The start-ups that managed to attract first-round financing run the gamut from Groundwork Open Source Solutions, an Oakland, Calif., network-monitoring software provider that received the first $300,000 installment of a multimillion dollar commitment from Canaan Partners to TurnTide, a Conshohocken, Pa., provider of anti-spam systems that attracted $1 million from Innovation Philadelphia. TurnTide was named one of Network World’s 10 start-ups to watch in 2004.

The largest first-round financing deal was an $8 million investment in Electriphy, which sells integrated circuits that provide fiber-like speeds over copper wires. Jim Apfel, CEO of Electriphy, says the Santa Clara start-up attracted seed money from Bay Partners and Lightspeed Venture Partners because of the next-generation DSL technology that Electriphy is developing.

“Venture firms look at the management team, the technology and the market. I think we hit on all three,” Apfel says. “We have a very strong team, all with a modem chip background. We have technology that no one else has. That’s our secret sauce. And the market for [very high-speed DSL] is one of the fastest-growing markets in access.”

Electriphy formed in 2002 and funded itself until the recent venture capital financing. It is demonstrating integrated circuit designs to system vendors and their service provider customers.

Apfel admits it’s difficult for network start-ups to attract seed and early-stage funding right now. “It’s definitely harder to raise money, but the people who raise money have a better chance of success,” he says.

Getting first-round funding was relatively easy for Bob Fanini and David Lilly, the co-founders of GroundWork Open Source Solutions. It took only three months for them to attract several million dollars in seed funding from Canaan Partners for their idea of creating a network management platform built using open source software.

“We weren’t even trying to raise money,” Fanini says, pointing out that he has founded five other companies. “Venture firms were interested in us because of our track record and the product niche. The niche isn’t so much network management as it is the open source positioning. That’s what got everyone’s interest.”

Another factor helping GroundWork is that the company already has a shipping product and 18 customers. “We were self financed and financed through customers,” Fanini says, adding that he hopes he won’t require additional venture financing.

Fanini predicts that seed and early-stage financing will pick up soon. “The market has been dry for a while – completely dry. People only invested in follow-on, late-round companies,” he says. “But around the first of the year people started thinking that the economy is picking up. We were one of the first companies to get money, but I think we’ll see a new trend in start-up investing.”

Overall, the amount of money invested in network start-ups held steady, meaning that fewer companies got more dollars. Altogether, venture firms invested $2.16 billion in the first quarter, a number comparable to the $2.1 billion invested in the first quarter of 2003.

One factor that’s helping prop up venture investments in network start-ups is that many companies are getting their fourth or later rounds of financing. Some of these companies are 10 or more years old, and they need continued investment until the IPO or acquisition markets become more active.

“The companies that have been around longer need more money whether it’s an expansion round or a later-stage round,” Walden says.

The top 10

Security and storage technology dominated first quarter venture deals.
Company Funding Headquarters Primary business
CipherTrust $42M Alpharetta, Ga. Enterprise security software and hardware.
Vonage $39.9M Edison, N.J. VoIP services.
Fortinet $39M Sunnyvale, Calif. Network protection systems.
nLight Photonics $32.3M Vancouver, Wash. Optical fiber infrastructure products.
3PAR $32M Fremont, Calif. Enterprise storage systems.
AdvanTech Solutions $26.2M Tampa Human capital management technology.
OutlookSoft $25M Stamford, Conn. Financial analytic software.
Softek Storage Solutions $25M Sunnyvale, Calif. Data management solutions.
Starent Networks $25M Tewksbury, Mass. Datacom equipment for wireless networks.
Speakeasy Service $24M Seattle Independent broadband service.

Most of the network start-ups that got funding were software ventures.

Software companies received $956 million, or 44%, of the total dollars. Software accounted for more than double the next-closest category, which was networking and equipment start-ups. They received $389 million, or 18%, of the total dollars.

Security and storage companies dominated this quarter’s top 10 deals, which ranged in size from $24 million to $42 million.

The MoneyTree survey trends ultimately might benefit enterprise buyers of network products and services, Walden says.

“It’s not all bad that companies have to have some customers before they get backing. That’s going to make it harder for the enterprise to get innovative products, but the start-ups that emerge should do better in the long run,” he says.