Business Tech

Hey buddy, can you spare a dime?

Venture capitalists put a virtual lock on their funding during the fourth quarter, doling out a mere $3.4 billion, according to a report released Monday by Thomson Reuters and the National Venture Capital Association.

The meager performance pales in comparison to the $11.7 billion distributed to start-ups a year ago during the same period. That's a decline of 71 percent. Funding is down nearly 60 percent from the previous quarter.

During the fourth quarter, venture capitalists launched 33 follow-on funds and 10 new funds, resulting in a 3-to-1 ratio for follow-on to new funds. That compares with a 2-to-1 ratio during the same period a year ago.

Mark Heesen, NVCA president, said in a statement:

The drop in venture capital fundraising activity in the fourth quarter is not surprising for two reasons.

First, the market uncertainty has compelled firms that were planning to raise a fund in late 2008 or early 2009 to hold back on fundraising efforts until economic conditions improve and institutional investors can recommit with confidence. The second and less obvious reason is that many venture capital firms raised money in the last two years and are focused on deploying those funds With some notable exceptions, we can expect this slower pace to continue well into 2009.

Such doom and gloom also engulfs venture capital spending as it relates to the tech industry, which posted its worst fourth-quarter performance in a decade, according to a recent report by VentureSource.

Venture capital for IT companies fell 40 percent to $2.18 billion in the fourth quarter, compared with the same period a year ago, according to VentureSource.

Editor's note: This is part of a series of stories about the recession's effect on the tech industry.

Entrepreneur Treb Ryan remembers in vivid detail the day the Dow Jones Industrial Average plummeted nearly 700 points and dropped below 9,000 for the first time in years.

Treb Ryan, OpSource CEO

(Credit: OpSource)

He was visiting a major computer maker on that day, October 9, waiting to meet with a potential investor about funding his start-up OpSource.

"I was about a half an hour early for the appointment and was sitting in the lobby, where they have a big screen TV," recalled Ryan. "Within the 30 minutes I was there, the Dow had dropped 300 points."

Ryan, OpSource's founder and CEO, still had his meeting with the prospective investor, but the discussion was initially dominated by talk of the market malaise. And two months later, the parties are still in discussions about funding his software as a service (SaaS) company.

For Ryan, the market meltdown and recession have made the task of securing a new round of venture funding far more difficult than OpSource's previous four rounds. To date, OpSource has raised a total of $45 million from investors. And the 41-year-old entrepreneur is currently seeking to raise a $20 million fifth round of funding for his Santa Clara, Calif., company.

Nonetheless, Ryan exudes optimism. "OpSource is not going away. SaaS is not going away. I know OpSource will survive and I look forward to the day when the markets pick up...I believe we will come out of this. I'm an optimist. That's why I'm an entrepreneur."

Ryan has reason to be optimistic. He's had some lucky breaks as an entrepreneur. In 1999, Ryan founded SiteSmith, a provider of managed Internet services. A year later, he sold it for $1.4 billion to Metromedia Fiber Network. It was one of the last billion-dollar mergers of the dot-com boom.

OpSource, by comparison, is nearly seven years old. The company, which Ryan notes has had interest from prospective buyers, is a SaaS company that manages virtually all aspects of running and hosting businesses online. OpSource has 200 customers, of which 40 percent are traditional companies, such as Adobe, that are doing some SaaS with their business. The bulk, about 60 percent, are dedicated SaaS companies, such as on-demand human resources company Taleo, that are using OpSource to provide the virtual behind-the-scenes plumbing.

Ryan isn't the only entrepreneur working overtime to land more funding. In the third quarter, venture funding of U.S.-backed companies fell 20 percent to $2.73 billion over the same time last year and dropped to levels not seen since late 2006, according to Dow Jones VentureSource.

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"Back in April 2007, we thought the public markets would be more open a year from now and we would be able to do an IPO," Ryan recalled. "But by this summer, with the market at 11,000, it was clear we wouldn't be able to do an IPO until the end of 2009. And now we're thinking maybe 2010."

As a result, Ryan said a decision was made to seek a late-stage funding round, with the goal of including strategic investors, as well. Meanwhile, the initial summer plans to raise a $25 million to $30 million round were scaled back in September to $20 million. Making it trickier: venture capitalists are placing much lower valuations on companies that are returning for additional funding.

"Valuations have been cut in half from where we expected in the summertime," Ryan said. "And that's pretty consistent with what we're seeing in the public markets (with where stocks are trading for public companies)."

With venture funding looking tight, OpSource has tightened its belt, as well. OpSource employs less than 200 employees, of which about 25 percent are in India. While OpSource has not had layoffs, it has reduced spending on sales and marketing.

OpSource has also gone back to its vendors and had success getting them to agree to lower their contract terms by double digits, but it came at the price of offering to extend the length of the contract.

Ryan has also applied some of this belt-tightening to his personal life. When Apple's new MacBook Pro debuted this fall, Ryan was tempted to snatch up the new laptop. But the CEO instead opted to install the latest Mac OS X version onto his old MacBook and squeeze another year of use out of the computer.

"I told everyone that if I have to do this at home, we can do this at work," Ryan joked. The married father of three added he's also sleeping easier at nights, now that OpSource began generating cash this month.

"Companies that stick to their knitting," he said, "are the companies that will stick around."

Coming up Friday: When times get tough, drop the satellite TV

Call it the elephant approach to sizing up the health of tech.

In two separate reports released Monday, Forrester Research CEO George Colony and Mayfield Fund weighed in on where they believe tech is headed in this challenging climate.

Colony, who took hold of the proverbial elephant's trunk, noted in his CounterIntuitive blog that the current recession will likely result in a tech spending slowdown, but nothing near the levels seen in the post-bubble-burst era of 2001 to 2003.

He noted CEOs and CIOs are indicating they plan to "change their way" out of the current economic doldrums, while the industry should find some comfort in the fact that technology has become more pervasive since the last downturn. So have the youthful Generation Y folks, 18- to 27-year-olds, who are far more wedded to their cell phones than previous generations, notes Colony.

Venture capital firm Mayfield Fund, meanwhile, noted in its fourth quarter report that its CEOs will rely on innovation, resilience and experience to "navigate the road ahead."

Here are a few CEO comments from the Mayfield Fund report that offer a proverbial feel of the elephant's leg, tusk, and tail:

Centrify CEO Tom Kemp: I am hoping the economic uncertainty will weed out some of our weaker competitors and cause our bigger competitors to not invest in the market.

Adchemy CEO Murthy Nukala: The combination of a recessionary macro-environment along with a dislocation of the online media landscape through advanced math techniques is creating a tremendous opportunity for performance marketing leaders like Adchemy.

Slide CEO Max Levchin: An obvious challenge--the economic downturn--is really a big opportunity for companies like Slide that can grow smart (e.g. hiring the best talent, maintaining excellent customer service, beating out competitors) during a recession.

Venture capitalists pulled back sharply on U.S.-based tech deals in the third quarter, pushing the flow of deals down to a level that hasn't been seen in more than a decade, according to a report released over the weekend by Dow Jones VentureSource.

During the third quarter, 270 IT-related deals were completed, a 21 percent drop compared with 342 deals in the same period a year ago, according to the Quarterly U.S. Venture Capital Report. That translated into $2.73 billion in investments, likewise down 21 percent from a year ago.

Software, which historically accounts for a large slice of all IT venture investments, fell 13 percent from a year ago to $1.15 billion. And the number of software deals declined to 125 during the third quarter, compared to 149 a year ago.

Within the information services sector, which includes a number of ad-dependent Web 2.0 companies, the level of investments and number of deals fell for the first time in three years, according to the report.

Information services start-ups raised $501 million during the third quarter--an 11 percent drop over the same time last year. A total of 64 deals were funded during the quarter, compared with 83 last year.

Start-ups that tout Internet-based consumer services also took a hit during the quarter, with funding falling 47 percent to $151 million in the quarter, compared with last year. The number of deals also dropped to 20 from 32 a year ago.

Outside of the statistics, venture capitalists and angel investors are driving the point home with their portfolio companies, issuing dire warnings to conserve capital, amid a climate where finding future pools of funding may be like searching for water in the Sahara.

The declines in the IT sector, which accounts for a sizable portion of all U.S.-based venture-backed deals, felt far more pain that the venture industry overall.

During the quarter, venture capital going to U.S.-based start-ups fell 7.2 percent to $7.37 billion in the quarter, compared with a year ago. And the number of venture deals dropped to 583 from 673 during the same time period.

"Clearly, the current economic crisis is already impacting the venture industry, which has traditionally been relatively insulated from fluctuations in the broader economy," Jessica Canning, global research director of Dow Jones Venturesource, said in a statement.

The California Supreme Court on Thursday upheld a long-standing state law ruling that employers can't restrict employees from working for a competitor or soliciting former clients when they leave the company.

That may be good news for California-based tech employees who want to take their skills to another company, or head a start-up that may directly compete with their former employer. "Noncompete" contracts, in place largely to protect an employer's intellectual property, began being used by companies during the dot-com boom to prevent losing valuable workers in a competitive technology labor market.

Microsoft and Google battled over a noncompete clause in 2005, when Google hired Kai-Fu Lee, an expert in speech recognition technology, even though he had signed a noncompete agreement at Microsoft. Google unsuccessfully worked to move the case from Washington to California, in hopes that the noncompete clause would be ruled invalid. The case was eventually settled outside of court.

The California law has been in existence since 1872, forbidding "noncompete clauses" that restrict management employees' options in their next job or business. But the law has been interpreted differently throughout the state, and the 9th U.S. Circuit Court of Appeals in San Francisco has ruled in favor of allowing a company to limit their employees' future job choices, as long as it doesn't prevent them from working in the same field.

Thursday's ruling was a response to the Edwards vs. Arthur Andersen case, stating clearly that Edwards, a tax manager, signed an invalid noncompete clause. The court said in its final disposition (see PDF) that "Non-competition agreements are invalid...in California even if narrowly drawn."