VCs still pinching pennies on network startups

Network/telecom companies managed to squeeze more money out of venture capitalists in the fourth quarter of 2002 than in the third, but that still didn't prevent last year from being the industry's worst for venture funding since 1998.

Similar findings were shown last week by the PricewaterhouseCoopers/Venture Economics/National Venture Capital Association MoneyTree Survey and the separate Ernst & Young/VentureOne report. Researchers cited the poor economy, the telecom meltdown and stingy IT budgets for the increasingly conservative venture market.

Seed, or initial, funding proved particularly elusive, according to the MoneyTree Survey. Just 15 companies in the network/telecommunications markets got such funding in Q4 vs. 19 in Q3 and 44 in Q4 of 2001.

Even where seed money is being invested, venture capitalists are generally putting in less, making sure a company's prospects look good before re-upping. Venture capitalists say they are putting more of their money into expanding portfolio companies, holding out hope that the initial public offering and merger markets come back.

"The focus remains on keeping existing portfolio companies afloat until the economy improves and liquidity can be attained," says Tracy Lefteroff, global managing partner for PricewaterhouseCooper's Venture Capital & Private Equity Practice.

Though venture capitalists say newcomers pursuing enterprise network dollars are finding a relatively receptive audience among investors compared to those looking to equip service providers.

"A number of [enterprise network] start-ups are doing well and are attractive, though it's hard to connect the dots and point to real trends," says Andy Rachleff, a general partner at Menlo Park, Calif.-based Benchmark Capital. "Companies either have to help lower costs now or solve problems no one else can solve."

Among the sectors getting the most attention are wireless LANs, security and data center management.

The MoneyTree showed that roughly 35 percent more money went to network start-ups in the fourth quarter, up to US$468 million from $347 million in the third quarter. The survey found that 48 network companies got funding vs. 41 in the previous quarter. But for the year, venture capitalists plowed $2.2 billion into network companies, less than half the $5.7 billion they invested in such companies in 2001, according to the MoneyTree survey. The survey also tracked funding of telecommunications companies -- service providers and those supplying service providers. Funding dropped from $641 million in Q3 to $562 in Q4, though the number of deals crept up from 71 to 79.

The Ernst & Young/VentureOne survey showed that there were 55 new rounds of network industry funding in Q4 vs. 56 in Q3, and that the amount of funding rose about 23 percent from $712 million to $875 million. For the year, venture capitalists put $4.2 billion into network companies, less than half of the $8.7 billion they invested in such start-ups in 2001.

Ernst & Young/VentureOne ranked 2002 as the fourth all-time in highest amount of venture funding, with $19.4 billion. But funding fell 44 percent from 2001's $34.6 billion.

Other survey findings included:

-- Only 30 percent of investments were for seed financing in 2002 vs. 37 percent in 2001, according to Ernst & Young/VentureOne.

-- The median size of deals fell between 2001 and 2002 from $7 million to $6.5 million, Ernst & Young/Venture One found. Among the few blockbuster deals during the fourth quarter was satellite system company WildBlue Communications' $156 million round.

-- Life sciences (consisting of biotechnology and medical devices) was the bright spot in the fourth quarter and the full year, according to the MoneyTree Survey. Some $960 million was pumped into startups in this industry in Q4, up 15 percent from the previous quarter.

-- Software in 2002 kept its top ranking among areas funded. Nearly 800 software companies raised a total of $4.3 billion in venture funding last year -- roughly 20 percent of total venture funding, according to the MoneyTree survey.

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