Venture funding drying up for start-ups

Venture funding for network start-ups hit a five-year low in the first quarter, as investors remained cautious in light of a continued industry malaise, concerns over the war in Iraq and the U.S. economy.

Sift through three quarters’ worth of VC data.

Venture capital firms put just more than $2 billion into network companies in the first quarter vs. $2.3 billion in the fourth quarter and $3.5 billion in the first quarter of last year, according to an analysis of the MoneyTree Survey compiled for Network World by PricewaterhouseCoopers, Venture Economics and the National Venture Capital Association.

The number of network start-ups invested in during the first quarter – 331 – is the fewest since the analysis of the survey began in 1997.

“Until we see customers start buying again, we’re going to be stuck at these funding levels,” says Tracy Lefteroff, global managing partner of the venture capital practice at PricewaterhouseCoopers. “Venture firms are also holding back new investments until they see some liquidity out there and that’s only going to happen if M&A and IPO activity pick up.”

Vendors need to show they can deliver customers an immediate payback to attract funding, Lefteroff says. Among the few segments faring well are storage and security, he says.

While carrier equipment suppliers such as Axiowave and Calix landed big funding rounds, severe cutbacks in carrier spending have made it hard for many such companies to attract investment.

“Carriers have lots of upgrading to do, but the question is: When are they going to free up their budgets to do that?” Lefteroff says.

Lefteroff says investments during the current quarter could turn out even lower than in the first quarter. “It’s not looking rosy from the data we’re seeing,” he says.

One company that has managed to get funding this quarter is KMV Technologies, a stealthy Austin, Texas, vendor of video products and services. KMV pulled in $18 million in first-round funding from Austin Ventures, Norwest Venture Partners and Redpoint Ventures. Craig Malloy and Michael Kenoyer founded the company, having previously played key roles at conferencing companies Vtel and ViaVideo (now part of Polycom). Vab Goel, a venture partner at Norwest, also is a founder.

Goel says that while videoconferencing seems like it’s been around forever, the timing has never been right for it to flourish because of chip costs, bandwidth constraints and other factors. “With the business world becoming more distributed and with more demand for real-time communications, this is the best time to invest in companies that work around video,” he contends. He also says there is no clear leader in the market, leaving the door open to newcomers.

“You’re making a mistake if you think you always have to do something new from an idea perspective,” he says. “When something is totally new and looks like a no-brainer, that’s actually the thing you don’t want to invest in.”