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.
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.
Gabbert said he expects these trends will continue through the year and should produce total venture capital technology deals worth more than $20 billion in 2004. The total number of closed deals should range between 1,800 and 2,000 this year, which would be the highest since 2001, he said.
However no one foresees a return any time soon to the outlandish investment rates of the bubble years when in the year 2000 alone venture capitalists closed 6,242 deals worth more than $94 billion.
A panel of venture capitalists and venture spending analysts said that among business applications enterprise resource planning, business intelligence and on-demand software subscription services seem to be getting the most attention from enterprise buyers.
Renting software online through subscriptions has major appeal to enterprises when they want rapid access to such applications as customer relationship management software, but they dont want to make a substantial cash or management commitment to it, said Stewart Alsop, general partner with New Enterprise Associates, a venture capital firm based in Menlo Park, Calif.
But this has its disadvantages. “Customers have so little loyalty and so little commitment” to subscription software that they can “pull the switch and walk away whenever they want,” Alsop said. This factor “is scary when you are investing in software companies,” he said. However, Salesforce.com in particular has validated the software subscription model, and this has attracted venture capitalist interest.
But “I dont think that the license model for software sales is dead,” Alsop said. “The license model still works when you need to get an entire organization committed” to using a particular software package.
However, Tad Piper, senior research analyst with Piper Jaffray & Co., said the on-demand software model also presents management challenges for IT.
Buying subscriptions is as easy as presenting a credit card number, which means unless IT controls this process, “suddenly you have 100 users that you didnt know you had.”