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Fourth-quarter VC funding stabilizes

Venture capitalists are handing out a little more cash to private companies than they have for a while--but analysts caution that times will remain difficult for fledgling businesses.

Venture capitalists are carefully handing out a little more money to private companies than they have for a while, according to a recent study.

The MoneyTree Survey by PricewaterhouseCoopers, Venture Economics and the National Venture Capital Association showed that VCs invested $7.14 billion in start-ups during the fourth quarter, a 2 percent increase from the $7 billion in the third quarter. The number of deals also increased to 856 from 810 in the third quarter.

"The free fall is over, and we've landed safely on higher ground," Tracy Lefteroff, a global managing partner at PricewaterhouseCoopers, said in a statement.

Software and biotechnology companies benefited most from the increase in funding. The biotechnology sector pulled in 14 percent of all investment dollars in the fourth quarter vs. 10.1 percent in the third quarter, while the software sector increased its share of the VC pie to 22.5 percent from 16.9 percent in the third quarter 2001.

The numbers reverse a trend in VC investment that started in the third quarter of 2000, when funding fell about 1 percent to $26.08 billion from an all-time high of $26.3 billion in the second quarter, according to the MoneyTree Survey.

Many venture capitalists were reluctant to finance start-ups because the value of technology stocks had plummeted, causing many start-ups to postpone or withdraw initial public offerings.

Research firm VentureOne says VC investment peaked at $27 billion in the first quarter of 2000 and has fallen every quarter since then. Funding even dropped 4 percent to $6.31 billion in the fourth quarter of 2001 from the third quarter's $6.57 billion. But it marked the smallest quarter-to-quarter decline since the boom times.

Both 2001 surveys look grim, however, when compared with the flood of investments start-ups received in 2000. VentureOne says the total amount invested in venture-backed companies fell to $32.1 billion in 2001 from the $91.6 billion in 2000, while the MoneyTree Survey records a drop to $36.5 billion in 2001 from $99.6 billion in 2000. Deals in 2001 also dived to 3,928 from 7,094 in 2000.

However, some still view 2001 as a lucrative year for start-ups, pointing out that funding in 2001 exceeded investment in 1998, the last so-called normal year before the funding frenzy began.

"How bad can $36 billion be?" said Kirk Walden, national director of research at PricewaterhouseCoopers.

And VCs continue to fund new companies. The MoneyTree Survey indicates that 78.5 percent, or $28.7 billion, of the $36.5 billion invested in 2001 went toward companies in the expansion or early stages of development. In 2000, 82.5 percent of the $99.6 billion went into young companies.

But Walden and others caution that times will remain difficult for fledgling companies. VCs will allow some portfolio companies to die this year to clean house and get ready to make new investments, they say.

"2001 was a difficult period in that the industry needed to go through a retrenchment and weeding out of companies," said David Spreng, managing general partner at Crescendo Ventures, a firm that focuses on investing in communications companies. "In many ways, it creates the most attractive environment that we've seen in years for investing in technology."

In fact, there is still plenty of money waiting to be invested. Jesse Reyes, vice president at Venture Economics, estimates that VCs have about $50 billion tagged for start-up investment.

But the question is where that money will go. Many say investors will take a far more prudent approach, now that the days of giving millions for a business plan written on a cocktail napkin have long since passed.

"Entrepreneurs with good business ideas need not worry about a lack of available capital but will have to worry about proving the viability of their business. That's business as usual," said VentureOne President Dave Witherow.