Venture Capital Funding Returns to Robust Levels

Venture capital funding in the software industry is returning to the more healthy levels seen before the Internet bubble years of 1999-2001. But venture investors are being pickier than ever about who gets funded.

REDWOOD CITY, Calif.—Investment in new software development startups is returning to the healthy levels observed before the 1999-2000 Internet bubble, but venture capitalists are being highly selective about the technologies and companies they invest in.

Venture firms these days are providing very little seed money to companies that are starting from scratch with little more than an idea and a few PowerPoint slides, said John Gabbert vice president of world research with VentureOne of San Francisco, the venture capital and private equity research arm of Dow Jones & Co. Inc.

Instead they are providing money for companies that are actively developing or shipping products, said Gabbert, speaking at the Enterprise Outlook 2004 venture funding conference here.

Venture investment in software companies in the 2004 first quarter totaled more than $4 billion, which puts it on track to match the level reached in 1998, the year before the bubble started growing for the next three years, he said. Between 1999 and 2001, venture funding of software companies exceeded $38 billion. This dropped to a total of $9 billion for 2002-2003.

Another positive sign is that the pre-money valuations of companies seeking funding have increased in recent quarters to the robust levels seen in the early 90s, Gabbert said. Early this year companies seeking funding had average pre-money valuations of about $4 million for first-round funding, $8.3 million for second-round and $20 million for later-stage funding. These are sustainable valuations that will keep the venture market healthy going forward, he said. Click here to read about three promising venture-funded companies. Business application software and connectivity/communications tools accounted for 52.9 percent of the 141 investment deals reported in the 2004 first quarter, according to Gabbert. Vertical market applications, multimedia networking, software development tools and database products shared the next largest segment with 38 percent of the funding placements.

Another indication that confidence is returning to the venture capital market is that in the first quarter firms made larger investments in the later rounds of funding, Gabbert said. Second-round and later-stage investments are averaging between $7.5 million and $8.5 million, he said. First-round funding was up slightly from about $4.5 million to $5 million.

Next page: Will trends continue?