Venture Funding Drops in First Quarter

A two-year trend of fewer early-stage companies receiving venture funding continued in the first quarter, with total private investment in startups dropping 24 percent, according to a study by the National Venture Capital Association, PricewaterhouseCoopers and Venture Economics.

For the first three months of 2002, venture investment fell to US$6.2 billion, 24 percent below fourth-quarter numbers. Only 787 firms were backed, compared with 994 in the previous quarter.

The first-quarter data comes after a relatively strong fourth quarter raised hopes that a venture funding recovery was already under way.

But analysts said the numbers, while dismal when compared with the peak years of the Internet and technology bubble, are still comparable to 1998 funding levels.

"The venture capital industry is cyclical," said Mark Heesen, president of the National Venture Capital Association. "It's important to put today's environment into perspective. Venture capitalists are back to being extremely selective about new investment opportunities and working to build companies that offer sustainable value."

Sectors Sagging

While technology continued to gain the lion's share of funding during the quarter -- the software sector led all categories with $1.1 billion in funding, and networking was close behind with $899 million -- investment increased primarily in non-technology areas.

In fact, information technology services saw the largest decline as funding of these ventures dropped 45 percent to $235 million.

Media and entertainment firms saw a 22 percent increase in funding to $371 million, while funding for business products and services rose 18 percent. Industrial and energy companies saw the biggest bump, up 37 percent from the fourth quarter.

Funding for medical devices and semiconductors both held steady at $409 million.

Waiting on Nasdaq

No significant upswing in venture funding is likely, analysts said, until the stock market has a strong enough run to sustain additional initial public offerings.

"The public markets appeared to be recovering late last year, but they were disappointing in the first quarter," said Tracy Lefteroff, a global managing partner at PricewaterhouseCoopers.

The first quarter saw one of the first e-commerce-related IPOs in recent memory when PayPal went public. Overall, though, the IPO market has remained slow, creating a backlog of firms in earlier stages of development, according to Lefteroff.

"The pipeline is clogged with venture-backed technology companies ready for public financing," he added. "A sustained recovery is unlikely until technology spending by corporations increases."

First-Time Buyers

As usual, venture capitalists focused on firms they had funded before, with 76 percent of investments going to companies that had received earlier capital infusions.

Still, the percentage of capital funneled to early-stage companies actually increased in the first quarter. True startups took 19 percent of all investment in the quarter, up from 16 percent the quarter before.

"It is encouraging to see that what new investment is being made, is being made in early-stage companies," said Jesse Reyes, vice president of Venture Economics.

Considering that dim IPO prospects make a short-term recovery of investment unlikely, he added, "It's a positive indicator that VCs are willing to take on more risk than they did in prior quarters."