Business Tech

Y Combinator on Monday announced that it has raised a $2 million venture fund with the aid of Sequoia Capital and angel investors.

In making the announcement, Y Combinator noted that it plans to increase the number of start-ups it funds to 60 a year, up from 40.

For Web services and software start-ups, that may bode well. Y Combinator focuses its investments on those two sectors and funds companies that are in their early stages.

As it notes, one unusual twist to this venture firm is its reliance on the strength of entrepreneurs' ideas, rather than on their business plans to support the ideas.

Y Combinator said it is ramping up its investments at a time when others are scaling back:

It's a big step for us to raise outside money. Till now, we'd only used our own. But we didn't want to let the bad economy make us conservative. Instead of hunkering down to wait out the recession, we want to expand to take advantage of it.

Y Combinator also noted that the quality of surviving start-ups is of a higher caliber during these economically trying times.

With the added funding in hand, Y Combinator extended its deadline for start-ups to apply for funding to March 25.

Venture capital investments in IT companies plunged 40 percent to $2.18 billion in the fourth quarter, their worst level in a decade, according to figures released late Friday by VentureSource.

The data further confirms concerns entrepreneurs have already been raising about a funding pullback by VCs over the second half of the year and dire warnings by the VCs themselves, such as Sequoia Capital's infamous R.I.P. PowerPoint presentation.

IT Venture capital dropped to $11.64 billion for all of 2008, down 14.5 percent from the previous year, according to VentureSource. During the past year, IT investments posted growth in the first quarter and a slight decline in the second, but significantly dropped off in the second part of the year, VentureSource said.

Software companies, which continue to capture the largest slice of IT venture investments, dropped 16.4 percent during the year, to $4.73 billion in funding.

Venture investments in communications and networking start-ups fell 32.3 percent to $1.68 billion in 2008, while investments in semiconductors dropped 23.5 percent to $1.25 billion year over year. Electronics and computer companies, meanwhile, saw venture investments fall 15.5 percent over the previous year, reaching $1.31 billion.

Despite the doom and gloom of 2008, the Web-savvy information services sector posted a 16.9 percent year-over-year gain in venture investments last year--to the tune of $2.67 billion. While that sector managed to shine through most of the year, venture investments did fall off 30.5 percent to hit $513.2 million in the fourth quarter.

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

Venture capitalists' confidence level took another hit in the third quarter, marking the sixth-consecutive quarterly decline for the Silicon Valley Venture Capitalist Confidence Index, which was released Wednesday.

The index fell to 2.89 points, nearing the midway point of a 5-point scale, with 5 ranking the highest confidence level.

According to Mark Cannice, associate professor of entrepreneurship and the founder of the University of San Francisco's Entrepreneurship program and author of the index, the faltering confidence level stems from several factors:

The unprecedented deterioration of macro economic conditions and the resulting impact on the venture capital business model were cited most often by this study's responding venture capitalists as the factors that negatively impacted their confidence in the near term environment for growth ventures.

While the lack of IPO exits has adversely impacted the (liquidity events) of the VC business model this year, the precipitous decline in the value of stock portfolios of some limited partners (e.g., pension fund asset managers) will likely limit the amount of capital committed to venture funds in the near term.

Since the first quarter of 2007, when the index stood at 4.38 points, the level of VCs' confidence has edged down every quarter. And in the last four quarters, the index has hit new lows since it was created in 2004. The index was derived from a September survey of 33 San Francisco Bay Area venture capitalists.