Venture capitalists apply the brakes

Venture capitalists slammed shut their wallets during the last three months of 2008, investing 45% less in Southern California start-ups than during the same period a year earlier, according to a report scheduled for release today.

The sharp fourth-quarter decline, to $422 million from $764 million, turned what was expected to be a full-year gain into a loss, according to the Dow Jones VentureSource report. Venture funding to the region's businesses in 2008 fell 20% to $3.2 billion.

There was just one bright spot: Investment in renewable energy continued its tear, climbing nearly tenfold for the year.

"The spend, spend, spend mentality is definitely over," said Frank Peters, chairman emeritus of Tech Coast Angels, which invests in Southern California companies.

Start-ups seeking funding suffered nationwide too, with fourth-quarter investments dropping 30% to $5.5 billion. The information technology and healthcare sectors were especially hard hit, falling 40% to $2.2 billion and 42% to $1.5 billion, respectively.

The grim numbers indicate that venture capitalists are hunkering down and waiting for the economy to heal before they take stakes in young companies. They seem to have come to that decision quickly, slowing their investments significantly from the third quarter to the fourth, when the financial markets crashed.

Peters said many of his colleagues at Tech Coast Angels decided to stop investing entirely for the rest of the year in October.

The Los Angeles area fared better than Southern California as a whole, with investment dollars rising 6% to $1.3 billion in 2008 from the previous year. L.A. recorded an annual gain despite a 46% drop to $105.8 million in the fourth quarter.

"It changed so fast over those three months," said Joe Marchese, who started looking for a round of financing for his L.A. company SocialVibe in September and closed a round in December. "From the time we started to when we finished, it was a different world."

Healthcare deals in Southern California fell 78% to $96.1 million in the fourth quarter.

The region's information technology sector, which includes companies such as Marchese's that work in the online media business, was one of the few areas of growth. Fourth-quarter investment in those companies, which generally don't require as much capital, grew 21% to $222.4 million.

Venture capitalists aren't anticipating that any of their companies will grow fast any time soon. Santa Monica venture firm Palomar Ventures started telling its portfolio companies to hunker down and cut costs in early 2008, managing director Jim Gauer said. It also told its companies -- including those that had been doubling revenue -- to plan for a flat 2009.

Gauer said his colleagues were worried that companies would have trouble selling their software or other goods to businesses in the current economy. "We think it's probably going to be a far more difficult environment than people are expecting," he said.

The number of deals nationwide fell 23% to 554 in the fourth quarter. In Southern California, the number of deals fell 19% to 51. Especially hard hit were very young companies.

"Nationally, venture capitalists are investing more in second-, third- and later-stage rounds to keep existing companies afloat," said Michael Schoenfeld, a partner of the venture capital advisory group for the Pacific Southwest Area at Ernst & Young.

The difficulty in securing early-round funding is leading some start-ups to just give up. Tony Katz, co-founder of Los Angeles company Aweli, which runs a website that helps monetize online videos, started looking for money in fall 2007. After not finding any backers, he and his partner reorganized the company and started looking again, to no avail. They gave up and will try to run on existing cash.

"The dreams we had to do some of the hires we wanted to do -- they're over," he said.


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