NEWS

The Deal's Year-End Analysis of Venture Capital activity

"The two most active venture capital firms in computer hardware and software startups were Austin Ventures and Benchmark Capital, which invested in 10 companies each in 2003."

What's Hot: 2003
by George White

5 January 2004
Daily Deal
Copyright (c) 2004 The Deal LLC

Startups continued to suffer in 2003 as total venture capital dealflow fell to $14.2 billion for the year, down 30% from the $20.7 billion raised in 2002. Unlike the prior year, 2003 lacked huge fundings to push its totals higher, as VCs continued to be unwilling to make big bets on early-stage companies. In 2002, there were nine fundings that topped the $100 million mark, while last year saw only one deal above that value.

Venture capitalists were also less likely to dole out fundings over $50 million. In 2002, 23 startups closed financings that surpassed $50 million, while 2003 saw only 21 companies receive venture rounds that large. VCs continued to favor certain sectors when deploying capital, with the biotechnology and healthcare industry capturing 33% of 2003's total dealflow, followed by wireless and telecom, with 19%, computer hardware and software, with 16%, and networking hardware and software, with 13%.

Although biotech and healthcare startups raised the most venture capital in 2003, both the number of deals and total funding were down from a year earlier.
The biotech industry reaped only $4.7 billion in new funding in 2003 from 310 deals. In 2002, biotech companies raised $5.4 billion, about 12% better than 2003.

Lifting the sector were large fundings for Reliant Pharmaceuticals LLC and Synta Pharmaceuticals Corp. Bridgewater, N.J.-based Reliant Pharmaceuticals landed the largest funding of the year, bringing in $252 million in a two-part fourth round. Previous investor Invemed Catalyst Fund LP led the round with participation from new investor Baystar Capital Management LP, returning investor Bay City Capital Fund III LP and other business interests of the Pritzker family. The specialty pharmaceuticals company was formed in 1999 to license or acquire small-market drugs developed elsewhere and market them to general practitioners through a large internal sales force.

Lexington, Mass.-based Synta Pharmaceuticals raised an impressive $75.3 million Series B funding from a group of individual investors including Bruce Kovner, chairman of hedge fund management company Caxton Corp., and Stanley Druckenmiller, chairman of investment firm Duquesne Capital. Other investors in the developer of anticancer and anti-inflammatory treatments included Robert Day, chairman of Trust Co. of the West and the Wolfensohn Family Foundation.

On the other side of the dealmaking table, the most active venture capitalists in biotech and healthcare in 2003 were life-science specialty firm MPM Capital, which invested in 15 companies, followed by Oxford Bioscience Partners, with 14 deals, and Alta Partners, with 13.
Although fundraising in the wireless and telecom sector fell 12% year-over-year, it wasn't hit as hard as other sectors. The sector raised $2.8 billion from 214 venture deals after pulling in $3.2 billion in 2002. Even with the decline in overall funding and the number of deals, the average size of a wireless funding climbed slightly higher to $12.99 million from $12.62 million.

At the top of the list of venture deals for wireless and telecom startups were Yipes Enterprise Services Inc. and NewSouth Communications. Yipes Enterprise Services came back from the brink in September with a $63.5 million refinancing. Formerly Yipes Communications Inc., the San Francisco-based company burned through almost $300 million in venture capital over a three-year period before it went into bankruptcy in March 2002. Yipes, a provider of networking services for businesses in metro markets, is hoping for more success its second time around-especially with signs of revival in the market for technology and telecom services. The company plans to succeed this time by being "very disciplined and very cash-conscious about how we run this company," according to Promod Haque, Yipes chairman and a general partner at Norwest Venture Partners.

According to Haque, Yipes' bankruptcy was necessary because of the cost structure of the business, established during the Internet bubble days. "It wasn't that the market for Ethernet services wasn't growing," Haque said. "The problem that this company had, as well as others, is that they had signed contracts for real estate, co-host space and fiber rings in multiple cities and they had signed at the peak of the market and these were long-term contracts that had to be renegotiated."
He added that the original Yipes could not continue with its tech-bubble pricing structure and, while it tried to renegotiate some long-term contracts, it was not happening quickly enough.

Investors in the post-Chapter 11 comeback include Focus Ventures, Glynn Ventures, J.P. Morgan Chase & Co., New Enterprise Associates, Norwest, Soros Private Equity Partners and the Sprout Group. NewSouth Communications, which offers broadband data, Internet and voice services to businesses in Southern states served by BellSouth and SBC Communications, dialed up $62.5 million in March. Backers for the Greenville, S.C.-based company included Kohlberg Kravis Roberts & Co., M/C Venture Partners, Quadrangle Group LLC, Vaxa Capital Partners LP and Wachovia Capital Partners.

Topping the charts for activity in the wireless and telecom sector were New Enterprise Associates and Intel Capital. New Enterprise Associates invested in 10 companies, including Yipes, doling out $255.2 million in 2003, while Intel Capital invested $167.7 million through eight deals.
Startups in the computer hardware and software industry had an even tougher time getting funding as 2003's dealflow fell 45% to $2.3 billion from $4.3 billion. The number of deals declined to 296 from 492, while the average deal size fell to $7.93 million from $8.69 million.

The largest funding in the computer hardware and software sector was SSA Global Technologies Inc.'s $75 million financing in April. The Chicago-based developer of customer relations and supply-chain management software received the capital from General Atlantic Partners and affiliates of Cerberus Capital Management LP.
The two most active venture capital firms in computer hardware and software startups were Austin Ventures and Benchmark Capital, which invested in 10 companies each in 2003.

One of the hardest-hit industries for venture funding was networking hardware and software, which tumbled 45% year-over-year. The sector pulled in only $1.91 billion in capital in 2003, after getting $3.5 billion in 2002.

Not only were VCs investing less capital in the sector-the number of deals fell to 171 from 240 -- but they also gave out less per deal, as the average deal size shrank to $11.17 million in 2003 from $14.63 million in 2002, a decline of 23%.

Picking up the rear were the downtrodden Internet sectors. Fundraising for 2003 in the Internet infrastructure and services industry plunged 40% to $566.6 million after securing nearly $1.4 billion in 2002. The sector saw the number of deals dive to 64 from 2002's mark of 124, while the average deal size shriveled to $8.85 million from $11.18 million in 2002. The Internet infrastructure sector suffered from a lack of large financings, as none of the 64 deals done in 2003 topped the $50 million mark. The sector's top funding went to ICG Commerce of Jenkintown, Pa., which raised a $35 million fifth round led by Internet Capital Group in January.
Other repeat investors in the e-commerce procurement technology and services company included Graham Partners, Cross Atlantic Capital Partners, SMM Five LLC, Wynnefield Capital and CIC Group. Eleven-year-old ICG has raised $200 million total of outside equity. The company's services are designed to help large corporations save money by outsourcing and streamlining the procurement process.

Illustrating how hard fundraising has become for Internet companies, ICG, which had raised $120 million in its 2000 fourth round, saw its previous valuation of $450 million cut to "considerably less than $200 million," according to one repeat investor involved in the deal.
Startups in the Internet commerce sector fared even worse as only $188.2 million was raised through all of 2003, 51% below the $391.1 million the sector gathered in 2002. The number of deals was slashed to only 20, after the industry recorded 67 in 2002. The sole bright spot was the average deal size, which jumped to $9.41 million, after posting a paltry $5.82 million in 2002.

Financing deals in the financial services industry were also down sharply, as the sector recorded only 15 deals raising $145.95 million. In 2002, financial services startups pulled in $555.79 from 71 funding deals, 73% better than 2003's total. Not only did venture capitalists fund very few financial companies, but they were also hesitant to make big deals in the industry. The average funding size for a financial services startup was higher, hitting $9.73 million, and up from the $7.82 million in 2002, although the sector didn't post any venture deals above $25 million in 2003.

Fundraising among media companies was down, but not nearly as much as other sectors. In 2003, 23 startups received $233.6 million in fresh funding, down 23% from 2002's $292.3 million from 39 deals.

And finally there was the 'other' category, which totaled $1.25 billion, where some of 2003's largest deals landed. The top two fundings in this sector went to Eclipse Aviation Corp. and CSMC Technologies Corp.

In July, Albuquerque, N.M.-based Eclipse Aviation closed on a $87 million fifth round to bring a new jet aircraft to market. The capital came primarily from individual investors, but the New Mexico State Investment Council chipped in $10 million. Eclipse, the largest angel investor-backed startup in history, has raised a total of $325 million for its plans to be the first aircraft manufacturer to sell jet aircraft for less than $1 million.

Venture capitalists eager to invest in China funded CSMC Technologies' $67 million first round in August. The financing for the Wuxi, China-based semiconductor manufacturing, foundry management and operating services company was co-led by 3i Group plc and Crown Crystal Investments Ltd. Other investors included China Resources Logic, a subsidiary of China Resources Holdings, a large Chinese conglomerate; IFC, the private sector arm of the World Bank Group; and a private equity fund managed by Templeton Asset Management Ltd.