Venture Investment: End of the Free-Fall?

Venture investing plunged nearly 50 percent in 2002, dipping to levels last seen in 1998, according to the latest MoneyTree Survey from PricewaterhouseCoopers, Venture Economics and the National Venture Capital Association (NVCA).

During the year, venture financiers invested just US$21.2 billion, compared with $41.3 billion in 2001.

But there is a silver lining to this thundercloud: A steady downward trend that had persisted throughout 2002 leveled off at years end.

In the fourth quarter of 2002, investments totaled $4.2 billion, down only slightly from the $4.5 billion sunk into startups in the third quarter. More companies received funding as well, with 692 businesses funded in the fourth quarter compared with 671 in the prior three-month period.

“I think the fact that the downward trend has leveled off is encouraging,” Jeanne Metzger, vice president of the NVCA, told the E-Commerce Times. “The levels we’re seeing now seem to be in line with the overall investment and economic climate. This seems to be the pace that venture investors are most likely to be comfortable with right now.”

Sector Watch

Among business sectors, only life sciences had a reasonably good year in 2002, taking the top spot from software with $4.7 billion invested. Of those funds, $2.8 billion went to biotechnology concerns.

In the technology arena, software companies remained the biggest recipient of venture funds, closing 799 deals worth a total of $4.3 billion, or about 20 percent of all venture investment, during the year. Telecommunications reaped 14 percent of the total, or $2.9 billion in 335 deals, and 229 networking firms brought in $2.2 billion.

Old Friends

Early-stage startups were hit especially hard in 2002. First-time financings fell 35 percent, with 756 companies landing initial funding rounds, down from 1,178 in 2001. Of those startups, 209 were software firms, while 61 were in the telecommunications industry.

The bulk of funding went to expansion-stage companies, which received 63 percent of the total payout. Overall, four dollars were invested in follow-on deals with existing companies for every dollar bet on a new startup.

Waiting for Payday

Metzger said the focus on more mature firms represents a desire to reduce some of the risk inherent in venture investing. It also reflects the current frigid state of the IPO and merger and acquisition markets.

“Venture capitalists still have a long-term view, but most want to make sure their bets are staggered in a way that provides the best opportunity for a steady payback over time,” she added.

Rosy View

But Steve Bengston, managing director for emerging company services at PwC, is more upbeat. He told the E-Commerce Times that a robust venture capital environment lurks beneath a cloud of “doom and gloom” left over from the late 1990s bubble.

“If you spend time focusing on the hundreds and thousands of companies that are the living dead left over from the bubble years, you could easily conclude that it’s horrible out there, that entrepreneurship is dead, that we’re going back to the stone age,” Bengston said.

In fact, however, 2002 still ranks as one of the five best years for technology venture investing of all time and one of the seven best for initial-phase investing, Bengston added.

“The venture business needs three things to do well,” he noted. “It needs money, which is had in abundance. It need technology in flux, which is certainly in place. And it needs talented people willing to work for startups. Most if not all of those qualities are out there. When we look back on this period in five years, I think we’re going to say it was a great time to be an investor.”