Venture capitalists scale back in the fourth quarter

Venture capitalists invested an average of $14.2 million in 1,345 companies in the fourth quarter, down from an average of $15.9 million in 1,785 companies in the third quarter, the trade group said.

The drop-off ended eight consecutive quarters of accelerating venture capital investment, peaking at $28.3 billion in the three months ended Sept. 30.

The fourth-quarter figure represented a 23 percent decrease from the comparable 1999 period.

Despite the decline late in the year, venture capitalists invested a record $103 billion in 2000, a 73 percent increase from 1999, the trade group said.

But the fourth-quarter slowdown heralded an about-face that is likely to last through 2001 and possibly beyond, according to venture capitalists and industry analysts.

"The industry has hit a bit of a rough patch. There are a lot of people who are trying to figure out what is going on," said Chris Noble, a general partner for Bay Partners, a 25-year-old venture capital firm in Cupertino.

The circumspection will likely push some venture capital firms to close up shop as they grapple with diminishing returns and encounter more difficulty raising more money for future investment funds.

"It's like the gold strike at Sutter's Mill," said Steven Lazarus, a managing director of ARCH Venture Partners in Chicago. "At first, everyone thinks they need to get out there and start panning for gold too. But once they get there and start panning, some people figure out it's not everything they thought it was going to be and decide to leave."

In recent years, pension funds and other institutional money managers have been eager to provide venture capitalists with money because the industry generated returns that outstripped most investment vehicles.

In the five years ending in 1999, venture capital funds generated an average annual return of 28.5 percent, according to Venture Economics, a research firm that compiles statistics for the industry trade group.

In the second quarter of 2000, venture funds registered an average return of 3.9 percent, the first time in 18 months that the industry's quarterly results had dipped into the single digits. The industry soon is expected to release figures illustrating the sub-par returns of the third quarter.

With the industry's returns shriveling, Lazarus said he wouldn't be surprised if venture capital investment dropped by as much as 35 percent during 2001.

If venture capital continues to taper off during 2001, it will represent the first annual decline since 1993 when the industry invested $4.9 billion, a 3 percent dip from the prior year.

No matter what happens in 2001, the venture capital industry is bound to remain much larger than it was before the World Wide Web transformed the Internet into a business hub and spawned a flurry of entrepreneurial activity.

Venture capitalists currently have about $35 billion in funds waiting to be invested, estimated Jesse Reyes of Venture Economics.

The turbulent investment climate is forcing venture capitalists to focus more on financing the existing companies in their portfolios instead of scouting new start-ups.

"There are some firms out there that aren't doing any new deals at all," Noble said.

In 2000, start-ups in their "expansion" or "later stage" received 74.4 percent of the venture capital invested during the year, up from 69.2 percent in 1999.

The collapse of online retailers and media companies continued to scare away venture capitalists in the final quarter of 2000. Venture capitalists invested $5.5 billion in e-commerce and content companies in the fourth quarter, down from a peak of $11.5 billion invested in the first quarter of 2000.<