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Start-ups take a third-quarter beating

Funding to VC-backed companies continues to dry up, but the grim news isn't shaking up the communications industry--yet.

Funding to venture capital-backed companies shrank again over the third quarter, revealing that the hard times for start-ups will most likely continue, though investment in communications companies isn't looking as grim, according to a survey released Wednesday.

The PricewaterhouseCoopers MoneyTree survey in partnership with VentureOne stated that venture capital firms invested about $6.49 billion in the third quarter, a 22 percent drop from the $8.37 billion invested in the second quarter and a 71 percent drop from last year's third quarter.

The numbers mirror a trend that has drained the venture capital industry during the past year. Funding peaked at $26.4 billion in the first quarter of 2000, fueled by runaway initial public offerings on the stock market that gave VCs incentive to fund more companies to take them public as quickly as possible.

With the collapse of the IPO market, start-ups are facing tough times. "Clearly, fewer companies are able to raise money, and those that are able to raise money, raise less," Dave Witherow, president of VentureOne, said in a conference call.

The median amount invested by venture capital firms in seed rounds fell from $1.5 million in the second quarter to just $500,000 in the third quarter, and the $18.5 million total amount invested in seed stage companies was the lowest since the first quarter of 1995.

The communications sector, however, managed to cut its losses. Communications companies raked in $1.58 billion, sliding only $322 million, or 17 percent, from the previous quarter's $1.90 billion. That compares with a 38 percent slide from the first quarter to the second quarter, and a nearly 42 percent drop from the fourth quarter of 2000 to the first quarter of 2001. The sector has attracted the most funding in every year since 1998.

"People realize that there are still interesting companies out there that are going to need money to last," said Jim Smith, an associate partner of Mohr Davidow Ventures, who focuses on the communications industry.

Smith believes the climate for start-up communications companies will remain tough, and he thinks more young companies in the industry will fail as the sector weeds out the stronger players. He added that communications investment strategy has changed over the past few quarters.

VC firms used to target their investments at technologies that would foster better performance such as gear to speed optical networks. Investors now focus their capital on new applications of technology like streaming media or video conferencing that can help carriers generate more revenue from their business customers.

"If you talk to carriers and other equipment makers in this sector, they will tell you that they have some serious revamping to do to their networks," said Tracy Lefteroff, a global managing partner at PricewaterhouseCoopers.

Lefterhoff also notes that VC firms still see good reasons to invest in communications companies, pointing out that the shrinking capital spending budgets of traditional carriers like AT&T and Verizon Communications still range in the billions of dollars, and that weakened start-ups are becoming more attractive acquisition targets for established equipment companies.

Yet, the overall hesitation in the venture capital world remains, as VC firms discover that money is harder to find. A report released Monday by Venture Economics and the National Venture Capital Association states that 46 venture funds raised about $6.17 billion in the third quarter, down from the 78 funds that pulled in $9.91 billion in the second quarter and the $17.9 billion raised by 109 funds in the first quarter.