February 4, 2002 Venture Capital Spending Rebounds; Fourth-Quarter Investment Jumps; The Increase in Funding, the First Quarterly Rise in Nearly Two Years, Could Herald an End to Mass Layoffs. by Matt Marshall Venture capital investments rose in the final three months of 2001, the first quarterly increase since the Internet bubble burst nearly two years ago. Venture capital firms pumped $7.1 billion into company start-ups nationwide, or almost 2 percent more than the $7 billion the quarter before, according to a MoneyTree Survey to be released today. The increase is significant, experts said, because a recovery in venture capital spending generally coincides with economic recovery. An about-face in venture funding could herald an end to mass layoffs. The VC survey is the industry's most in-depth, compiled by accounting firm PricewaterhouseCoopers, together with research firm Venture Economics and the National Venture Capital Association. Silicon Valley soaked up more than one-third of the fourth-quarter capital. Investments here rose 14 percent, to $2.5 billion, from $2.2 billion the quarter before. Biotech and software companies enjoyed most of the lift. The numbers are a relief for those who couldn't see a bottom during lastyear's hair-raising 66 percent plunge in venture investing. "We've clearly bottomed," said Greg Waldorf, venture capitalist with Charles River Ventures. Silicon Valley, with its dependence on the start-up ecosystem, has the most at stake in a VC recovery. But the jury is still out on just what the data portends. The good news: Venture investing is stabilizing at a higher level than the pre-bubble era. Total investments in 2001 were still higher than those in 1998. The bad news: The jump in the fourth-quarter data was small, and it may turn out to be illusory, caused more by venture firms stubbornly investing in existing companies -- hoping against hope that they might survive --than by vigorous renewal of seed investments. Jesse Reyes, vice president of Venture Economics, who looks closely at the numbers, said that it's too early to tell: "I don't see it as necessarily getting better. It just hasn't gotten any worse." The survey follows the release of another survey last week, by VC research firm VentureOne, that showed a minor decline of venture investments in the fourth quarter. One of the valley's most successful venture capitalists, Vinod Khosla, of Kleiner Perkins Caufield & Byers, remains a skeptic. He said the effects of Sept. 11 haven't been accounted for yet. That's because there are lags in the data, he said, and the fourth-quarter figures might actually reflect a jump in the third quarter. According to his reading, there was a "hiccup" in March and April, when the stock market hit a new low. Companies starved for funding had to wait until the summer to get it. Though a venture capitalist might have committed money to a company in July, the deal might have taken two months to close. A start-up might wait another month or two to announce the funding --pushing back the announcement to the fourth quarter. In sum, Khosla said, "We have yet to assess the impact of Sept 11." Venture Economics' Reyes conceded the survey might have missed part of Sept. 11's impact, but not all of it. Other developments have muddied interpretation of the survey. Investments in seed and early-stage start-ups continued their decline. The 40 companies started during the fourth quarter were fewer than the 46 of the third quarter, and the lowest level since 1998. Khosla, for one, said he believes the fourth quarter might have been a bottom for the number of new companies funded. But for existing companies, the worst might not be over. Up to 80 percent of those kept alive during 2000 and 2001 are likely to die, Khosla said. "It could take another nine months for them to hit the wall," he said. Many of those are start-ups in the telecommunications and networking equipment sectors, where venture investments declined most sharply. Sanjay Subhedar, a partner at Storm Ventures who specializes in the telecom sector, thinks 2002 will be rough. "We'll continue to triage," he said. "Which ones do we support, which ones do we kill?" An upturn won't come until next year, he predicted. In the meantime, he said, as many as 80 percent of the companies started between 1999 and 2001 will fold. And venture capitalists will continue to focus on keeping alive their most promising prospects. Khosla, for instance, said he forced one of his companies, OnFiber, to cut back its monthly expenditures in March to about $1.3 million. With $45 million in the bank, the start-up has staying power. It now hopes to expand its position by buying up assets on the cheap, as its competitors fall by the wayside. However, Khosla, like others, believes things will get better this year. As Paul Koontz, a venture capitalist with Foundation Capital put it: "We're beginning to feel some sensation in the limbs." {CHART} CHART TOP VALLEY FUNDINGS These companies received the highest amounts of venture funding in the Bay Area during the 2001 fourth quarter. (Figures in millions.) YEAR COMPANY CITY FOUNDED PRODUCT AMOUNT SS8 Networks San Jose 1999 IP signaling $62.0 Zambeel Fremont 1999 Storage systems $52.6 QuickSilver Technology San Jose 1998 Wireless technology $50.0 Avolent San Francisco 1995 Internet billing $40.0 Callidus Software San Jose 1996 Enterprise software $40.0 Source: PricewaterhouseCoopers/Thomson Venture Economics/National Venture Capital Association MoneyTree Survey CHART: MERCURY NEWS VC turnaround? Source: Source: PricewaterhouseCoopers/Thomson Venture Economics/National Venture Capital Association MoneyTree Survey