January 23, 2006

Venture Capital
Hits Highest Level
In U.S. Since 2001

Venture capitalists poured more money into U.S. companies last year than in any year since 2001, reflecting a growing appetite for Internet-related start-ups and later-stage deals.

The amount raised in 2005 by U.S. venture-backed companies hit $22.13 billion, a 2.2% increase from the $21.65 billion recorded in 2004. The investment total rose despite 10 fewer companies receiving funding -- 2,239 versus 2,249 -- according to industry tracker VentureOne, a unit of Dow Jones & Co., publisher of The Wall Street Journal.

In the fourth quarter, venture-capital investments rose 2.6%, as 588 companies received $5.31 billion versus 581 companies and $5.18 billion in the year-earlier quarter.

Lower Costs

The traditional sectors sought by venture capitalists -- health care and information technology -- experienced a drop in funding for the first time in several years. But the far smaller consumer and business-services sector, which encompasses retail and Internet-commerce companies, produced gains in 2005 not seen since the dot-com boom days.

Fueling this investment shift is the lower start-up costs for Internet companies, which are benefiting from open-source software and cheap online memory and storage technology.

"The toolset to create these companies is a lot easier than it was during Internet 1.0," said Joel Cutler, managing director at General Catalyst Partners, a consumer-services investor based in Cambridge, Mass. "The bar for starting a company like this is a lot lower."

Imitating Success

Gordon Ritter, general partner of business-services investment firm Emergence Capital Partners of San Mateo, Calif., said the consumer experience is migrating into the office space. "Customers use Amazon and eBay at home, and they go to the office and say, 'I want an HR system that works like that,' " he said.

Investments in consumer and business services saw a significant jump in 2005, as 270 companies in 2005 received $2.42 billion in venture capital, up from 227 companies and $1.58 billion in 2004.

Health-care and information-technology companies didn't fare as well in 2005. Life-science investments totaled $6.7 billion for the year, down 3.9% from $6.97 billion a year earlier. Likewise, the dollar value for information-technology investments fell 4% to $11.97 billion from $12.45 billion last year.

Moving Away

Last year also saw more later-stage deals than in 2004, due in part to iffy public markets and an abundance of capital being managed by venture-capital firms. Venture capitalists funded 5.3% more later-stage companies in 2005, or 796 companies compared with 756. The amount invested equaled $10.6 billion, an increase of 14% from the $9.29 billion invested in 2004.

In 2005, investments in companies receiving seed, first- or second-stage rounds fell, with investors funding 1.4% fewer companies than the year before. Those rounds totaled $9.1 billion, 10% less than the $10.12 billion recorded in 2004.

Peter Rip, managing director at Leapfrog Ventures, a Menlo Park, Calif., early-stage investor, said he thinks the shift of dollars to later-stage deals results from the significant sums of money investors are putting into venture-capital funds. All of this money moves investors away from lower-cost early-stage deals, he said.

Write to Jonathan Matsey at jonathan.matsey@dowjones.com¹