February 25, 2004

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Palo Alto Online

Venture-capital investments point to recovery

by Muoi Tran

After three years of nightmarish decline, some in the world of venture capitalism are daring to dream pleasant dreams again.

One point of proof: Venture capitalists raised $5.2 billion in the final three months of last year, more than double the amount billion collected during the same period in 2002. All told, about $18 billion were invested in about 2,000 U.S. companies last year.

Sure, it's nowhere near the funding levels of 2000, when VCs backed three times as many companies in the U.S. to the tune of $106 billion.

But steadily rising levels of confidence and a willingness to invest are definite signs things appear to be settling into new normal, local VCs say. And it's a welcomed sign.

"VCs are tired of looking in the rear view mirror and have attempted to identify the winners and losers in their large portfolios," said Don Wood, a general partner at the two-decades-old Palo Alto-based Vanguard Ventures. "They are now focused on the hoped-for winners and are beginning to invest in new teams and new ideas again."

John Drew of Palo-Alto based Technology Crossover Ventures agreed that investors are willing to risk again after a few years of caution.

"Technology is heating up, investors are more confident, and I think we're back to days that are fairly normal," said Drew, a general partner. Technology Crossover Ventures, which was founded in 1995 and has backed companies such as Fandango and Netflix, recently announced that they raised $900 million for their newest fund.

A new hopefulness is what Maha Ibrahim, a principal at Menlo Park-based Canaan Partners, sees when she looks out over the VC landscape. An increasing number of companies are being acquired and going public, and that's spurring optimism and investments, she said.

One benefit for entrepreneurs in this new, calmer reality, Ibrahim noted, is that they are retaining more ownership of their companies. Even though they might not be getting the large sums of VC money like they did a few years ago, they're getting enough to survive, and keeping more of the company's value at the same time.

Some VCs are looking back to the times before the investing frenzy, around 1995 to 1997, to redefine what is normal. Entrepreneurs today must have working prototypes of their ideas -- and a few customers -- before they will be considered for funding, according to Peter Fenton, a general partner at Accel Partners. During the hot Internet years, ideas were often sold on PowerPoint slides. Accel Partners, based in Palo Alto since 1984, has backed over 200 software and networking companies including Foundry and Redback, both of which are now public.

Today's investors are much more seasoned and will proceed with caution, Fenton added, unlike those in 1999 and 2000 who were relatively new to the field. For example, social-networking technology has received much attention lately, but probably fewer than 10 such companies have received funding, he said.

"What I see today is that people are backing companies with real usage. Friendster already had tremendous usage and consumer adoption," he said.

Online security and digital entertainment and communications, including technologies and applications for iPods and cell phones are also attracting the interest of the new VC funds. According to the MoneyTree Survey, in the fourth quarter of 2003, 173 software companies received nearly a billion in funding out of almost $2 billion invested in Internet-related technologies.

Looking forward, Wood of Vanguard Ventures expected more VCs will come back into the market to raise new funds, as the larger funds raised in 2000 slowly get invested.

"2004 will likely see a larger investment level, and 2005 will be even larger," Wood said. "Still, it will not return to the incredible funding level of 2000 when more than $100 billion were invested in 629 new funds."

VCs have regained confidence and optimism, but the ripple effects of the Internet bubble burst are still evident and will continue to affect the VC environment, according to Wood.

Currently, about 500-1,000 companies are being backed by VC funding in the United States -- a "more sustainable rate" than when 3,000 new startups were launched annually, he said.

But there are about 7,000 private, VC-funded companies in limbo from the previous funding cycle.

"Perhaps 200-300 of these companies will go public during the next five years, and perhaps 1,000-2,000 will be acquired by larger, healthier companies," Wood added. "This is not good news for the other 5,000."

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