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Following the money: What are VCs funding?

While investments in start-ups continue to grow, venture capitalists are shunning some formerly hot sectors and returning to more conservative ones.

The turmoil swirling around many tech stocks and the dicey market for initial public offerings is causing previously bullish venture capitalists to pull in their horns.

While the number of deals and the amount of money being invested in start-ups continues to grow, venture capitalists are shunning some formerly hot sectors and returning to more conservative investments.

Internet infrastructure companies, which in essence contribute toward the foundation, pipes and streets that constitute the Internet, are among the investments attracting attention, venture capitalists say. And they note that managed services companies, which provide support for Web hosting and wireless applications businesses, also are receiving interest from venture firms.

Fiber-optics and wireless deals, meanwhile, continue to hold favor among venture investors, even though these two industries have already produced a number of IPOs.

All of these sectors are part of the larger categories of communications, information services and software--which historically rank among the top investment areas for venture firms, according to research company VentureOne. In other words, venture capitalists are returning to funding business models that have produced results in the past.

"Communications, in some form, has always been a driver of the information age," said Sasha Talebi, research director for VentureOne. "Information services and software, leveraged by the Internet, have created an unprecedented environment for doing business globally with fewer barriers to entry. It's never been cheaper or easier to compete on such a scale with limited resources. Most venture capital investors recognize this."

For individual investors, as well as some institutions, tracking venture capitalists can be useful because they place bets on sectors and companies they think the public markets will embrace several quarters or years from now. And with the markets currently in a downtrodden mode--the Nasdaq is down some 20 percent in the past several weeks--investors may wish to take a more futurist view on their investments.

While there has been a shift in the types of businesses receiving funding, the overall level of investments has remained strong. During the second quarter in 2000, the most recent information available, VentureOne reported that venture-backed companies raised $17.2 billion. Communications companies represented 12 percent of the funds raised, information services 13 percent and software 21 percent.

Last year, venture-backed companies raised $8.1 billion in the second quarter, with communications accounting for 23 percent, information services 12 percent and software 18 percent.

Janice Roberts, a general partner with the Mayfield Fund, concurred that Internet infrastructure companies are one area of interest for her firm.

"We're interested in technology that makes things faster and more reliable," Roberts said. "A lot of companies, like Web sites, were developed quickly on thin foundations. Now it's about fundamentals and core technology."

Jake Reynolds, general partner of Technology Crossover Ventures, agrees. His firm focuses on companies that build technologies for the Internet's infrastructure, as opposed to companies that use the Internet as the platform for their operations.

"We're investing in wireless data companies and hardware and software infrastructure companies, but less e-commerce and professional services investments are being made," Reynolds said.

No let-up in sight
Despite the recent market turmoil, venture capitalists are continuing to fund young tech companies. These are the number of deals financed and the amount of money raised:  
Industry Sector 2Q '98 2Q '99 2Q '00
  Communications     80/$612 mil.     91/$1.9 bil.     129/$4.3 bil.  
  Electronics     25/$116 mil.     24/$278 mil.     17/$235 mil.  
  Information
Services
    40/$308 mil.     121/$1.1 bil.     141/$2.1 bil.  
  Semiconductors     20/$156 mil.     24/$198 mil.     34/$526 mil.  
  Software     138/$865 mil.     174/$1.4 bil.     218/$3.0 bil.  
Source: VentureOne
Technology Crossover Ventures has investments in Internet infrastructure companies such as BeVocal, a voice portal company; Copper.com, an Internet-based voice equipment maker; and CoreExpress, a corporate data delivery service provider.

Charley Lax, a general partner for Softbank Capital Partners, is bullish on opportunities in the managed services arena. "The data center is dead and a lot of ASP (application service providers) applications are moving onto the Web. As a result, there's a need for a lot of service and support work."

Interliant, which manages Web sites, is one such company that has received a Softbank investment, Lax said. The shares, however, have slumped horribly--they closed Monday at $6, well below their 52-week high of $55.50, ending down 44 cents, or about 7 percent.

Nonetheless, the number of managed services companies is growing. In the past 12 months, dozens of these companies have formed, Lax noted.

Early-stage investors, who participate in the initial round of funding and carry the most risk, are looking at managed services companies, database services and marketing companies, he added.

Meanwhile, late-stage investors, who typically arrive on the scene toward the later rounds of financing to help a company just prior to a public offering, are taking stakes in wireless and fiber-optics companies.

"The later-stage investors are more comfortable with the significant outlays (of funding) required by infrastructure companies that are laying the foundation for future generations of the Internet and (the Web)," Talebi said. "It's not cheap to lay down fiber across 3,000 miles or under an ocean. But when complete, the rewards are immense."

Although venture firms have a number of investments in the optical arena, Roberts said there is still room for new entrants in optical services, components and equipment.

Mayfield, for example, announced Monday that it invested in four Iris Group optical companies. These companies include optical systems maker Metera Networks, long-haul optical backbone systems provider Latus Lightworks, optical networking systems maker Coree Networks and Iris Labs.

see story: Cashing in on fiber optics Although several venture firms are making investments in fiber-optics companies, Lax said enthusiasm for the sector may die down as early as next quarter.

Funding for wireless companies, meanwhile, remains strong. Talebi said venture funding goes back as early as four years, when a feeding frenzy kicked off in commercializing wireless services and products. Adoption of long-awaited wireless standards for personal communications helped drive that frenzy, which to a lesser degree was propelled by deregulation in the 1996 Telecommunications Act.

"Wireless is a proven business model...This is why those same, risk-averse investors are funding wireless plays," Talebi said.