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Have Startup Valuations Stabilized?

Communications company valuations haven't budged in six months, but startup investment levels continue to fall

November 15, 2001

3 Min Read
Have Startup Valuations Stabilized?

Venture-backed startups had to wait longer for fewer investment dollars during the third quarter of 2001. But there are some signs that the valuations of startups, which went into freefall in late 2000, are beginning to stabilize.

Though no one's calling this the bottom of the economic downturn, prolonged stability in valuations is generally a sign that the worst part of a recession may have passed.

Venture-backed communications and networking companies had a median pre-money valuation of $32 million during the third quarter of 2001, according to VentureOne, a venture capital research firm. That's down 55 percent from the year-ago period, but it is also the highest valuation since the fourth quarter of 2000, when the economic bubble officially burst in most sectors. The median valuation for a communications company during the third quarter of 2000 was $72.65 million, the highest in at least six years. That plummeted to a median valuation of $25 million in the fourth quarter of 2000.

What's more, $32 million is slightly higher than the six-year median valuation for the communications sector, which is $29.5 million. These numbers appear to indicate that venture valuations are returning to a long-range norm, a sign that the climate is beginning to stabilize for VCs and startups (see VCs: Guilty or Innocent? ).

Despite the fact that valuations appear to be stabilizing, that doesn't necessarily make it any easier to find money. And because many companies raised money at the sky-high valuation levels of 2000, they risk serious dilution in taking money at the new, lower levels.

Only 9 percent of the venture-backed companies eligible for a Series B financing round during the third quarter were able to get the needed funding, according to VentureOne. During the year-ago quarter, roughly one out of every six companies got the Series B funding they needed.

The Series B market was at its frothiest during the fourth quarter of 1999, with some 22 percent of the eligible pool of companies getting Series B financing.

Companies who did get their Series B funding in the third quarter of 2001 had to wait, on average, nearly 14 months between their first and second funding rounds -- the longest average wait since at least late 1995, VentureOne says.

"I think that in general there are still great opportunities in the communications sector," says Erel N. Margalit, managing partner for Jerusalem Venture Partners. "However, specific individual companies in this sector still continue to have trouble raising money."

If the wait didn't kill companies seeking funding, the less weighty investment amounts might have. Venture-backed communications companies raised $1.58 billion in 91 funding rounds during the third quarter, compared to the astonishing $6.18 billion raised in 205 rounds during the year-ago period, according to VentureOne and PricewaterhouseCoopers. In one year, the size of the average funding round dropped to $13 million from $19.75 million.

Given the lack of liquidity opportunities, its no surprise that venture investment amounts have dropped off so significantly (see VCs Wait for Liquidity).

The companies that have found funding have needed to settle for lower valuations. Venture-backed company valuations declined across almost all industry segments during the third quarter with one noteworthy exception -- the communications industry, which includes optical networking companies.

"My recommendation to the people who have been dedicated to the communications space is to keep at it," says Margalit. "The medical field and other industries may seem hot right now, but in a time of difficulty, people should focus on things they know best."

- Phil Harvey, Senior Editor, Light Reading

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