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Is venture capital's love affair with Web 2.0 over?

VC investment in Web 2.0 increased in 2007, Dow Jones VentureSource says, but strip out the Facebook deal and a different picture emerges.

Silicon Valley remains the hotbed of Web 2.0 activity, but the hipness of start-ups with goofy names is starting to cool in the face of economic reality.

Dow Jones VentureSource on Tuesday released numbers of venture capital activity in Web 2.0 companies and declared that the "investment boom may be peaking."

Venture capitalists put $1.34 billion into 178 deals in 2007, an 88 percent jump over 2006. But once you strip out the $300 million that Facebook raised from Microsoft and others, the numbers don't look as bullish.

The pace of deal flow, or the number of fundings, has slowed, particularly in the San Francisco Bay Area. Deal flow in 2007 went up 25 percent to 178 deals, but nearly all of those occurred outside the Bay Area, where the number of deals slipped downward.

"Web 2.0 deals in the Bay Area actually dropped from 74 deals in 2006 to 69 last year and investments were down 3 percent from the $431 million invested in 2006. It's clear that the real growth in the Web 2.0 sector is happening outside of the Bay Area," Jessica Canning, director of global research at Dow Jones VentureSource, said in a statement.

VC deals for Web 2.0
Breakdown of VC deals in Web 2.0 in 2007 and 2006 Dow Jones VentureSource

The second largest deal in 2007 was a $44 million first round for Ning, a service co-founded by Marc Andreessen that lets people build their own social-networking sites.

The New England region saw 20 deals valued at $158 million in 2007. Southern California had 14 fundings worth $115 million, while the New York Metro area had 25 deals worth $58 million. The Seattle area had 13 worth $140 million in 2007.

The median size deal has gone up to $5 million, but that is still a relatively cheap investment for venture capitalists. Start-ups can get off the ground efficiently by using open-source software and inexpensive hosting services.

But even with the relatively low capital risk, particularly compared with clean tech, Canning said that many Internet companies still have unproven business models that rely on future advertising revenue.

"2008 may be a make-or-break year for many Internet companies with business models relying on advertising," she said. "The slumping economy, coupled with a slowdown in click-through rates for online advertising, is going to pose a real challenge to their ability to generate revenues and position themselves for an exit."