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VC investment slide continues

After a brief pause that suggested the worst might be over for beleaguered start-ups and investors, the dramatic slide in venture capital investment continues.

After a brief pause that suggested the worst might be over for beleaguered start-ups and investors, the dramatic slide in venture capital investment continued, according to research released Wednesday.

Investment fell to $6.23 billion in the first quarter, down 23 percent from the $8.13 billion in the fourth quarter, according to the MoneyTree survey compiled by PricewaterhouseCoopers, Venture Economics and the National Venture Capital Association. The number of deals also fell 21 percent to 787 from 994.

The decline is a steeper sequential drop than in the fourth quarter, when investment fell a revised 3 percent from $8.39 billion.

Researchers believe that an anemic IPO market and less spending by businesses on information technology products have made it very difficult for start-ups to establish themselves.

"A lot of these companies that are in the IT sector are dependent on commercial sales for their revenues," said John Taylor, vice president of research for the National Venture Capital Association. "It's very difficult when businesses are not buying things related to information technology for (start-ups) to develop the kind of track record they need to go public."

The beating software start-ups took in the first quarter provides evidence of this trend, as investment in the sector fell 43 percent to $1.06 billion from $1.87 billion in the fourth quarter. Telecommunications companies also took a hit, attracting $722 million from investors, a 41 percent drop.

The reduced funding puts private companies in a bind and has left many without the means to go anywhere.

"The funding downturn has created this backlog of companies," said Tamar Zemel, a spokeswoman for VentureOne, a VC research firm. "They are a lot of companies that received funding that are in limbo right now."

A survey by VentureOne and Ernst & Young released Monday shows that first-quarter funding fell 26 percent to $5.1 billion from $6.9 billion. Investment in IT-related companies fell 17 percent to $3.46 billion, and health care financings slipped 29 percent to $1.13 billion.

Even though the MoneyTree and VentureOne surveys both show that funding dropped 79 percent and 81 percent, respectively, from the first quarter of 2000, which was the peak period of investment, some industry observers believe the dramatic decline has helped the industry return to more sound, pre-boom investment practices.

VC firms are more likely to invest with other firms in start-ups to minimize risk, and investors have started to focus on developing a company over a period of years before taking it public, rather than months.

"There was a brief period when one could tap the public market and raise large amounts of money," said Howard Cox, a general partner at Greylock. "In the history of venture capital, that's very rare, values are generally built over a long period of time...and I think we're just back to the more historic nature of the (industry), which is building businesses."

But for now, VCs and entrepreneurs say they need a strong stock market to bring investors back to participating in IPOs, which will reduce the backlog of private companies that are ready to go public. No one knows for sure when this will occur, but many believe that it will not happen anytime soon.

"A lot of the recovery we're looking for is very contingent on the public markets," Taylor said. "We're not seeing factors that are likely to pop back around in the second quarter."