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Are venture capitalists warming up to tech?

VentureOne's John Gabbert shares new data with CNET News.com suggesting that venture capitalists may be shedding their reluctance to fund technology start-ups.

John Gabbert has watched start-ups, ever-thirsty for venture funding, crawl through a veritable desert for three years.

Gabbert, vice president of worldwide research for Alternative Investor and its VentureOne arm, says that ever since tech's bubble burst, VCs have been reluctant to pour money into any start-up. But on Monday, Gabbert released statistics that suggest a change may be in the offing.

According to VentureOne's second-quarter figures, venture capitalists sequentially increased the number of deals and the dollar amount invested into start-ups across all industries. The last time that that sort of sequential uptick occurred was the first quarter of 2000.

During the second quarter of this year, venture capitalists pumped nearly $4 billion into start-ups across all industries, up 13.6 percent from the previous quarter. Also, the number of deals increased to 442, a 4.2 percent increase sequentially.

While that's good news for start-ups in general, the tech sector still has a ways to go in order to catch up to the high-paced action of the go-go days. Although the increase in the number of tech deals rose to 274 in the second quarter, up 2.6 percent from the previous quarter, the amount of dollars invested remained roughly flat.

Gabbert recently spoke to CNET News.com about the outlook for venture capital funding and what it means for new tech companies.

Q: Does this second quarter indicate a turnaround for venture investing?
A: I think that it is too early to say if this is a trend. It is also important to keep in mind that the second quarter is still below investment levels of the fourth quarter last year. Nonetheless, it was good to see the investment level increase by 14 percent and strong investment levels within the health care segments and software.

It's been a long dry spell for venture funding. What's driving the increase in the total number of deals and the amounts of money being invested?
I think there are multiple factors. The first quarter was challenged by a number of things happening in the world: the pre-war jitters and then the war. We were also coming off a quarter of tough liquidity with virtually no IPOs in that quarter. And historically, the first-quarter cycle is usually the down quarter.

Software has always been a bellwether investment for venture capitalists.
Even though industries overall saw a rise in both number of deals and dollars raised, the tech industry did not fare as well. Why did tech fail to see the increase in second-quarter investment dollars as did other industries?
I think that it has to do with a few things. One is the amount of money that investors were willing to invest in companies, given current risks. I would also imagine that VCs are implementing more milestones for these companies to reach in order to get more funding. The median investment amount is small for each deal, relative to past investments.

While IT companies accounted for more than 60 percent of the deals in the second quarter, the various tech sectors had mixed success. The software sector was the only one that managed to post an increase in both the number of deals and the amount invested. Why was that?
Software has always been a bellwether investment for venture capitalists. With the economic risks today and the type of capital expenditures that companies are looking for, there is still a lot of investing in software--if it can make a company more efficient.

The communications and networking sector was down in both the number of deals and amount of dollars invested in the quarter. What were the contributing factors?
The telecommunications industry has been extremely hard hit, from Lucent Technologies to Cisco Systems and others. The market for this type of equipment is virtually nonexistent. Of the hundreds of companies that are looking for financing, only a small fraction of the communications sector has been successful. The fiber optics deals were in the hundreds in 2000. But during the first half this year, only 32 deals have been made.

It seems that the telecommunications industry wasn't alone. Both the information services and semiconductor sectors also posted declines in the number of deals and the amount raised in the quarter. Why did they perform poorly, too?
The information services industry involves a lot of consultants as well as data management or data warehousing. Businesses that are cost-conscious tend to be so when it comes to consultants, and so we have seen a fair amount of slowdown in investing in these companies.

Semiconductor deals still have some good activity there. Whether a report from Intel or others related to mobile computing, there seems to be greater interest in this sector than there is in information services.

In looking at where the big money went, software maker InPhonic topped the list of all companies in all industries with its $56 million financing round. Why was that? What was special about its wireless voice operation?
This was its sixth round of financing, and usually, the later the round, the larger the financing. But even given that notion, this was a pretty large investment for a software company. There is a lot of interest in wireless and mobile computing, and these guys had registered in November to go public.

Within IT, what sectors are particularly hot with investors?
Within software, communications software takes the lead. That would be things like wireless communications software, followed by general business applications software. Over the last few years, there's been greater attention to connectively.

Do you foresee a day when the health care industry, which is currently hot, will bump the IT sector to second place in the number of venture deals and dollars invested?
I don't think so. The state of IT would have to be incredibly bad for that to happen, or there would need to be a revolutionary breakthrough in bio-pharmaceuticals, similar to the Internet. Given what we know today, it would take a serious change one way or another.