Article

Posted on Mon, Oct. 25, 2004

Venture investing down last quarter
THERE'S NO CAUSE TO PANIC, EXPERTS SAY
By Matt Marshall
Mercury News

Venture capitalists invested fewer dollars into Silicon Valley start-ups during the third quarter, reflecting a national trend.

The slowing comes after five consecutive quarters of investment increases, in what many participants assumed was a steady recovery since venture investments bottomed in the wake of the Internet bubble burst in 2000. Venture investing has been rejuvenated in recent years by a variety of growth industries, including Web services, wireless and biopharmaceuticals.

Venture capitalists invested $1.54 billion in Silicon Valley start-ups during the quarter, down 24 percent from the second quarter, according to a quarterly survey released by Ernst & Young and VentureOne.

However, experts said they believe investing is still steady, if not growing slightly. They suggested the quarterly data may not capture the full investment picture -- pointing to reasons like a seasonal summer slowdown when venture capitalists take vacation.

Indeed, local investments levels are up 1.3 percent from the same quarter a year ago, when venture capitalists invested $1.52 billion.

Also, many start-ups delay reporting their investments, a ``stealth'' tactic designed to avoid alerting competitors. So quarterly levels are typically revised upward later by about 4 percent, said VentureOne's vice president of research, John Gabbert. And recently, that revision number seems to be growing, he said.

In other words, while venture investment levels certainly aren't skyrocketing, there are few signs of a noteworthy drop-off in activity. ``I don't think there's anything earth-shattering,'' he said.

The rate of venture investing is important because it is the lifeblood of young, fast-growing companies that have traditionally done the most hiring in Silicon Valley.

Nationally, the picture was similar. Investments were $4.56 billion, down 16 percent from the second quarter, and down 4 percent compared with the third quarter of last year.

Growing amounts of money going into start-ups at the earliest ``seed'' stage may also be biasing the data, Gabbert said. Younger companies raise less money than more mature ones. Venture capitalists typically invest $1 million or less to help them get off the ground, and wait to see if their business merits follow-on investments.

After the Internet bubble burst in 2000, fewer seed companies were started, Gabbert explained, meaning fewer companies are now raising second and later rounds of funding, when dollar amounts are generally higher.

Indeed, ``seed'' and first-round deals -- those classified by VentureOne as early-stage rounds -- made up 31 percent of all venture capital deals this quarter, compared with 28 percent a year ago. That's a positive sign for the future, Gabbert said. Both information-technology and health-care companies saw the highest total amounts invested in seed-round deals in more than two years.

On the other hand, second- and later-stage deals posted declines, both in number of deals and amount of money invested. Still, those are the sorts of companies that tend to hire more quickly.

Several venture capitalists said they see activity levels remain buoyant. ``Business is definitely building up steam,'' said Peter Morris, general partner at Menlo Park's New Enterprise Associates. ``There's a lot of capital, and a lot of projects being done.''

Morris led a $45 million investment, to be announced today, in a San Bruno e-mail security company, IronPort. That money will help it hire more people, Chief Executive Scott Weiss said. IronPort plans to hire 100 employees by next year, 80 of them in Silicon Valley.

``Activity is clearly up,'' said Tom Alberg, a partner at Madrona Venture Group in Seattle, a venture firm allied with Silicon Valley firms in its investments.

He said his firm had made four new investments over the past year.

However, many others say they're looking to fund start-ups but just aren't finding enough good companies. Gadi Behar, managing director of Silicom Ventures, a large angel investing group that claims about $6 billion in assets, sees about 200 pitches a month from companies. But the group funds only one company. It has been disappointed by the caliber of the ideas or the start-up teams, Behar said.

``Many companies are out there, but they're not attractive for investors,'' he said.
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