Venture Capital Dry Spell Ends

Venture capitalists increased their investments in the second quarter, marking an end to two straight years of declines, and the telecommunications industry received a larger pot of the money.

During the second quarter, the telecom industry represented 14.5 percent of the $4.3 billion in venture capital investments, up from 12.5 percent, according to the PricewaterhouseCoopers/ Thomson Venture Economics/National Venture Capital Association MoneyTree Survey.

Seventy telecom companies that had previously received funding raised an additional $615 million during the second quarter, up 21 percent from the first quarter.

Kirk Walden, national director of venture capital research with PricewaterhouseCoopers, says companies may require six or more rounds of funding during a five- to seven-year period.

VC firms remain reticent to fund telecom companies for the first time, however. Only 11 telecom companies received VC funding in an initial funding round during the second quarter, according to the survey.

In 2000, venture capitalists invested a staggering $106 billion to fund nascent companies. Many of those dollars went into hightech and telecom firms. Two years later, overall VC investment for the United States fell to $21 billion.

The telecom sector has raised anywhere from $500 million to $670 million during each of the last five quarters, according to Walden.

“I think telecom would be very very happy if they were to finish the year in the $2.2 billion to $2.4 billion range,” he says. “That would mean they are retaining their prominence relative to other industries.”

According to the survey, in the second quarter the most active VC firms in telecommunications by the number of investments included Austin Ventures, Redpoint Ventures and US Venture Partners. These firms each invested in three telecom companies.

Tom Dyal, a partner with Menlo Park, Calif.- based Redpoint Ventures, says, “Most of the new projects in the telecom space are still unfundable” because a tremendous amount of capital is required and there is a limited customer base.

For example, Dyal comments that it costs about $100 million to fund a startup telecommunications equipment maker. “The days when we had lots of new service providers are past and I don’t see that changing,” Dyal says. In other words, equipment makers are vying for the dollars of a finite number of large service providers, and that challenge is not alleviated, even when phone companies increase their capital spending on network infrastructure.

However, venture investors are willing to continue to be supportive of existing portfolio companies in the telecom industry that have made it this far, since they’ve demonstrated enough positive execution to warrant continued funding, says Edward Olkkola, a general partner with Austin Ventures. “Much ‘weeding and feeding’ has taken place over the past [two to three] years,” he adds. “Those companies continuing to receive funding have solid management teams, blue-chip customers, distribution partnerships, solidly competitive products and a path to operating profitably.”

But only the results of a venture capitalist’s exit strategy will reveal whether the long-term investment was truly worth the risk. And the number of initial public offerings — one way a firm can get its payday — is sparse. So, despite this upturn in telecom VC investments, Mark Heesen, president of the National Venture Capital Association, says it is premature to declare a turnaround in the market. “The venture industry invests based on anticipated future market conditions, so before we declare a trend reversal, we must first see a sustained opening of the IPO market and consecutive quarterly increases in corporate capital expenditures,” Heesen says.

Today the most obvious exit strategy available to venture capitalists is a sale through a merger or acquisition, Olkkola says, although investors are not guaranteed the returns they are seeking. Olkkola says if investors and management focus on “building a great company,” the exit strategy takes care of itself. “In doing so, acquirers will make the first move to engineering an exit,” he says. “Fundamentally if the team is executing aggressively and well, time does not therefore become an issue because the performance of the company will be noticed.”

Dyal of Redpoint Ventures underscores his VC firm is typically committed to a company for the long haul. “The idea is ‘let’s fund companies and set them up so they can be successful as independent businesses,’” says Dyal. “Rarely is it in our best interest to sell out early on a company.”

Dyal says a VC firm can make a decent dollar if it invests a nominal amount of money to position a company to reach cash flow breakeven: $15 million to $25 million, for example, rather than $100 million. “I think where you can create those kinds of companies on a limited amount of capital, you can be very successful as a venture capitalist in this climate,” he says.

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