VC start-up funding down again

Venture capital investments in network start-ups continued a two-year downward spiral during the third quarter, dropping to the lowest levels since early 1998.

That’s the finding of a special analysis of the quarterly MoneyTree Survey compiled for Network World by PricewaterhouseCoopers, Venture Economics and the National Venture Capital Association.

The survey found that venture capitalists invested $2.3 billion in 345 network start-ups during the summer, down 21% from the $2.9 billion invested in the previous quarter. The third-quarter investment levels is 86% below the peak of the ‘Net investment boom, when venture capitalists poured $16.3 billion into 1,107 network start-ups in the second quarter of 2000.

Software companies continued to dominate investments, representing more than half of the network industry deals completed in the third quarter. The number of software deals was four or more times those completed in other areas, including IT services, network equipment, semiconductors, telecommunications and computer systems. The most popular areas for software investment continue to be network security and storage.

Experts say the decline in investment in network start-ups is the result of the overall economic downturn, which began in the second quarter of 2000. The third quarter of 2002 was particularly hard hit by stock market volatility, weak corporate earnings, and dormant IPO and acquisition markets.

Sift through six months’ of data from the survey.

“Communications companies aren’t buying anything,” says Tracy Lefteroff, global managing partner of the venture capital practice at PricewaterhouseCoopers. “Corporate capital budgets have been cut. Network equipment vendors are dying on the vine, announcing rolling rounds of layoffs. And I don’t think we’ve seen the bottom yet.”

While overall investments are down significantly, 20 network start-ups managed to receive cash infusions of $20 million or more. The largest deal was a $62 million first-round investment in Exigen, a San Francisco provider of business process software for the insurance, banking and government industries.

Other major deals include a $45 million investment in Hatteras Networks, a Durham, N.C., provider of last-mile carrier access platforms, and a $34.6 million investment in Luxn, a Sunnyvale, Calif., maker of optical systems for service providers.

Lefteroff predicts the fourth quarter will see another decline in both the number of deals and dollars invested. In order to see the venture market turn around, Lefteroff says corporate IT spending has to start rising (see related story).

“We need to see the businesses that have been the buyers of IT and networking equipment start to increase their capital budgets,” Lefteroff says. “We need to see the overall economy improve. . . . A lot of companies are going to need to see a quarter or two of sustained growth before they’re going to want to put their toes back in the water.”

Lefteroff also predicts that more venture-funded network companies will go out of business in the next six months as they deplete funds raised during late 2000 and early 2001.

“Companies generally raise about two years’ worth of money,” Lefteroff says. “I think we’ll see a fairly significant amount of shutdowns as companies exhaust all their options, and the venture guys give up.”