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VC funding levels keep heading lower

Funding for venture-backed companies falls for the fifth quarter in a row, a survey finds, sliding 21 percent.

Funding for venture-backed companies fell for the fifth quarter in a row, sliding 21 percent as those seeking early rounds of financing got hit the hardest.

Companies received $8.2 billion in funding during the second quarter, compared with $10.4 billion in the previous quarter, according to a PricewaterhouseCoopers MoneyTree Survey in partnership with VentureOne. During the quarter, 669 companies received funding, an 11 percent drop from the first quarter.

The median amount they received fell to $8.5 million in the second quarter, compared with $9 million in the previous quarter.

Companies looking for early rounds of funding saw their slice of the pie cut down to a third of total funding from half, the survey found. Comparatively, companies trying to get funding in the later stages saw their figure rise 8 percent to $2.8 billion in the second quarter from the first quarter.

The median late-stage deal size, however, dropped to $12.6 million in the second quarter from $18 million in the first quarter.

"This data really suggests that most VCs are focused on their existing deals?and are probably taking time to work through their portfolios before we?ll see a pickup with early stage financing," said Tracy Lefteroff, global managing partner of the venture capital practice at PricewaterhouseCoopers.

Venture capitalists have pulled in the reins as the prospects for IPOs and buyouts have dramatically slowed during the past year with the markets' sharp decline. A greater reluctance by investors to throw as much money into venture funds is also adding fuel to the fire.

Venture capitalists also note that other issues loom large.

"When you look at funding an early stage company for the first time, you expect that company will need future financing in another 12 to 24 months," said Jack Harrington, a general partner with Advanced Technology Ventures, a VC firm. "If the financing environment 12 to 24 months out has low visibility, you may feel cautious and may back away until that becomes clearer to you."

He added, however, that he anticipates the amount of money going to early stage investments next year to be larger than this year.

Communications and networking companies saw much of the quarterly decline in funding, accounting for roughly half of the $2.2 billion drop-off. Fiber optics and photonics companies were among the hardest hit within that industry--two groups that previously had garnered a large portion of investments during the past 12 months.

"Many of the sectors within communications were over-funded for a lengthy period," said Nick Sturiale, senior associate with VC firm Sevin Rosen Funds. "We may have had a dozen start-ups within each communications area funded, so it's understandable we?re having a healthy decline now."

Sturiale added that interest in funding communications companies has waned as a number of telecommunications carriers--which represent potential customers and acquirers of these start-ups--have encountered financial difficulties themselves.

As to when the funding environment for newly created companies in this sector will improve, Sturiale says the "hangover always equals how drunk you got. Everyone will drink a couple of Alka-Seltzers and come out of it eventually."

Meanwhile, as money flowed out of high-tech investments, it migrated into the life sciences and health care group. That segment received a 6 percent increase in funding to $1.3 billion during the second quarter.

Overall, the quarterly decline in venture funding may bottom out within the next two quarters, said Dave Witherow, chief executive of VentureOne, a venture capital research company.

"The rapid pace of decline coming off the bubble is starting to taper off," Witherow said. "I will be satisfied if the quarterly investments stay around $6 billion a quarter. That would show a healthy environment for venture investing."

He also noted that VCs he has talked to within the industry have indicated that they do not expect VC funding to drop below $5 billion a quarter, which would put the industry back to the levels recorded around 1998.

And for the year, he added that he expects funding in venture-backed companies to reach between $30 billion and $35 billion. That would fall far short of the nearly $90 billion invested in companies last year and down from the $47 billion invested in 1999.

Although equity investments will pale in comparison to the go-go days of the past two years, Witherow noted that when excluding the bubble period, venture capital is still maintaining its growth rate from the previous decade.