Ante Up In A Down Market

Venture capitalists have their hands on the tap, but they can't seem to turn it off. VCs poured a total of $25.9 billion into 1,774 companies in the third quarter this year, according to the latest findings from market researcher Venture Economics and the National Venture Capital Association. That represents a slight decline from the last two quarters, but it's far from the dramatic downturn that many had expected as dot-com mania waned in recent months.

The amount of venture capital invested in 2000 now stands at almost $80 billion. That's a hefty increase from the nearly $60 billion invested in all of 1999. But last year saw phenomenal growth as well: total funding surged an average of 59 percent each quarter. This year, venture funding is holding relatively steady at about $26 billion per quarter, while returns are actually falling. "VCs are taking a breather," says Jessie Reyes, vice president of Venture Economics. "They're more circumspect about the types of companies they fund."

VCs are also redirecting the cash flow and reducing their funding of early-stage start-ups from one quarter to one fifth of all transactions. That suggests venture capitalists are focusing more on funding existing portfolio companies. "There's a shift away from frenzied first-round investing as VCs budget for future rounds," says Reyes. "The trend will continue for the rest of this year."

Companies that focus exclusively on the Internet accounted for 45 percent of total investment, down from 50 percent in the second quarter. Communications companies accounted for 18 percent of deals, and computer software and services came in third at 12 percent. Several Internet-related sectors fell out of favor. Funding for Web software and tools dropped from $4.1 billion in the second quarter to $2.8 billion in the third. Money for e-commerce and content companies fell from $10.3 billion in the second quarter to $7.7 billion.

Although capital continues to flow, returns are diminishing. They hit the skids in the second quarter, producing a 3.9 percent internal rate of return, according to a report released earlier this month by Venture Economics. That number was far less than the high of 59 percent reached in the fourth quarter of last year.

"Returns have to drop for a significant part of the venture business," says Jim Breyer, a venture capitalist at Accel Partners, which recently raised a $1.6 billion fund. "We told every one of our limited partners that we didn't expect to post the same kind of returns we've seen over the last few years."