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Venture funding slowed by recession

The recession has hit venture capital funding so hard that it’s reverted to levels not seen since before the dot-com boom of the last decade.

Funding for start-ups fell 50% in the first quarter from a year earlier to $3.9 billion, the lowest since 1998, as venture capital firms conserved their cash and focused on existing investments, a report scheduled for release today says.

The information technology category, which includes both software and hardware firms, was hit hard nationally, falling 52% to $1.68 billion, the report by Dow Jones VentureSource says. The investment was the smallest in that sector since 1997, and the 231 deals were the fewest since 1995.

“The first quarter was pretty ugly,” said John Morris, managing director of venture firm GKM Ventures, which focuses on communication, semiconductor and digital media companies. “Anybody that has cash doesn’t want to spend it until they have better visibility on their plan forward.”

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Funding to Southern California firms fell 35% to $462 million. At $150 million, L.A. firms received 40% less funding than they did a year earlier.

Investment in energy and utilities, a previous bright spot, fell 59% nationally to $189 million. The decline was even sharper from the last three months of 2008, falling 79% from the $886 million the sector attracted in the fourth quarter.

The reasons for the decline are familiar: Venture capital firms, unable to sell or merge the companies they had invested in, don’t have the cash to pump into new companies; stock markets are sharply down from their peak, so angel investors don’t have much money with which to seed new companies; and investors are focusing on saving their existing companies, rather than finding new ones.

But some venture capitalists say this decrease in funding could be a positive development -- a “right-sizing” from the last few years, when firms put too much money into too many companies that didn’t deserve it. Both those firms and those start-ups are getting weeded out, said Mark Suster, a partner at Los Angeles fund GRP Partners.

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In the near term, the market may see more start-up failures and some venture capital funds disappear, he said, but that may strengthen the investment world in the long term.

“We’re back to the basics now, and I think it’s really quite healthy,” said Mike Napoli, president of the Tech Coast Angels Inland Empire Network.

On a cheerier note, some Southern California numbers are up from the end of 2008, said Mike Schoenfeld, a partner in the venture capital advisory group at Ernst & Young.

“What you’re looking for in today’s environment is continued increases,” he said.

Total funding to Los Angeles firms rose 35% to $150 million from the fourth to first quarter. The healthcare sector in Southern California overall, which includes Los Angeles, Orange and San Diego counties, nearly tripled from the fourth quarter of 2008, to $272 million. But that’s still a 24% decrease from the first quarter of 2008.

Nationally, six of the eight largest deals for the quarter were in the healthcare sector, and five of those companies are located in California.

The bad news for small start-ups, Schoenfeld said, is that much of this activity was focused on later-stage deals. Of the top eight deals nationally, only two were first-round deals.

Venture capital firms “were focusing on existing investments and making sure they were surviving in this financial crisis and recession we were going through,” he said.

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alana.semuels@latimes.com


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