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Growing companies catch venture capitalists' eye

As the markets roiled in the second quarter, expansion-stage companies--those shipping products--received the most attention from venture capitalists, according to a survey.

Age is everything when it comes to venture funding.

As the markets roiled in the second quarter, late- and early-stage companies found a shifting sentiment among venture capitalists, according to a PricewaterhouseCoopers Money Tree survey released today.

Late-stage businesses are those that are generating revenues, on a path toward profitability and most likely headed for an IPO, while businesses not yet shipping products are considered early-stage companies.

The survey, taken from 660 venture firms in the second quarter, found late-stage companies suffered a 27 percent drop in investments to $1.6 billion, while early-stage companies received a 3 percent increase to $8 billion. Meanwhile, the number of companies funded by venture capitalists fell by a sizable 35 percent for late-stage companies and by 8 percent for early-stage operations.

But it was expansion-stage companies, those that are shipping products, that ran counter to the group, with a whopping 66 percent jump to $7.8 billion for investments received and a 31 percent increase in the number of companies landing financing.

Overall, the number of companies receiving VC investments grew by less than 1 percent to 1,432 in the second quarter from the previous period. But investments grew nearly 15 percent to $19.6 billion in the second quarter, showing venture capitalists had money to burn for the right companies, despite the markets' downturn.

"There was a flight to quality," said Kirk Walden, national director of venture capital research for PricewaterhouseCoopers.

Late-stage companies received a cool reception from venture capitalists. That changing attitude came as venture capitalists watched the IPO market virtually dry up last spring, reducing their chances of getting a profit out of companies that typically command higher valuations.

But for late-stage companies that were able to land investments, the average amount received increased to $24.7 million, a 15 percent rise, since fewer companies were competing for financing.

"A lot of companies weren't able to do an IPO, so they had to go back to the well," Walden said.

He added that in some cases, investors sought a valuation that was lower than the previous round--creating angst for the companies and their earlier investors.

Venture capitalists also took more of a wait-and-see approach when it came to investing in early-stage companies.

"They doled out smaller chunks in the first round and basically told them to come back in six months or so if they were still around, instead of having them wait until a year or more for their second round," Walden said. Such a move reduces the amount of money a venture capitalist could lose if the business plan doesn't pan out in the first year.

But expansion-stage companies received the most attention from venture capitalists, Walden noted. This group offers lower valuations than late-stage companies but not as much risk as early-stage companies.

In slicing venture investments based on industry groups, technology companies received a 17 percent increase to $18.7 billion in the second quarter, compared with the previous period. And of this group, Internet companies posted a 7.6 percent increase to $11.7 billion in the period, according to the study.

Investments in content and business and consumer e-commerce sites declined in the quarter, tempering the Internet sector. But the tools and applications sector helped drive the rise in technology investments by a 35 percent quarter-over-quarter jump.

And in sizing up the current trend, Walden said it's unlikely the third quarter will slow down, despite continued volatility in the markets and the typically slow summer period.

"I see no reason why the investments can't continue at this current level of $15 billion to $19 billion," he said. "A lot of folks are thinking it will go down. But with so much money under management by these VCs, they have to put it to work."