VCs Tighten Their Purse Strings

Investments may be cut in half this year, but that's still a lot of moola for startups.

Companies looking for venture capital financing this year will find there is still plenty of cash available, but it may take a Herculean effort—or simply a credible business plan—to grab a slice of it.

The heyday of easy money is certainly over, but the VC well has not run dry, according to numerous industry analysts and high-tech players.

Last year, VCs invested more than $100 billion in startup companies. That figure is expected to fall sharply this year. Conservative estimates forecast a $40 billion to $50 billion investment pool this year, says Jesse Reyes, VP of global product management at Venture Economics. Ken Anderson, managing editor of VentureWire Group, is more bullish. Anderson predicts VCs will invest a healthy $80 billion this year.

Tougher for Startups Anderson and Reyes agree that VC investing during the last two years was an anomaly. "Venture capital spending will probably be significantly lower than last year, but if you take last year out of the equation, spending is still well ahead of a few years ago," says Anderson.

Looking back, VC funding last year broke all records. Venture capitalists pumped more than $100 billion mainly in technology and IT-related companies, analysts say. Thats about double the amount invested in 1999, according to VentureWire and Venture Economics, a division of Thomson Financial Securities Data.

Although billions will be invested this year, the consensus is those dollars will go into fewer deals, making it more difficult for the average startup to get its hands on venture money. "It will be very tough for startups with anything that smells like it should have been done a few years ago," says Reyes.

Predictably, venture capitalists will be staying away from anything with a dot-com after its name. "Too many venture capitalists thought they were making technology investments, but in the end were making a basic retail investment," Reyes says. Such was the case with fallen companies like eToys and

Also making it tough for startups to raise money is the stone-cold IPO market. Established private firms, which expected to cash in on the public market, are returning to their investors for additional rounds of financing. And even those companies will have a very tough time attracting new investors.

East/West Capital, a venture capital firm that invests in digital media, for instance, plans to limit its later-round investing in companies in which it already has a stake, says Ravin Agrawal, partner at the firm.

Good Bets So, what type of companies and services will attract the money? Optical technology is high on everyones list, as is wireless. But even those will be closely scrutinized.

VentureWires Anderson expects a possible shakeout in optical, which is glutted with startups. Even optical leader Nortel Networks is warning of slower growth this year.

Meanwhile, wireless technology may take longer than expected to come to market. After all, wireless standards like Bluetooth havent exactly set the world on fire. "Enterprise software may be an area they return to," says Anderson.

Some VCs will pump their investments into tools and infrastructure, says Reyes. "Life sciences and biotech will attract money, and there will be some Internet-related investments," he says. "But the companies will have to be able to make money quickly and prove there are significant barriers to entry."

In health care, where many venture capitalists were burned by a cadre of e-health companies, there are still opportunities, according to Barry Scheur, chairman of Venture Health Partnership Group. He says hot areas include companies developing new systems for claims processing and billing, eligibility and enrollment verification, and health-care benefits information for consumers.

Also, pharmaceutical companies may provide some of the later-round funding for those companies, says Deborah Buresh with Shattuck Hammond Partners.

Either way, dont expect easy money.