VCs Invest Less In IT, Sort Of

But other types of ventures receiving investors' money heavily depend on technology to exist.
Venture capitalists, on first glance, seem to be shifting their investments away from IT companies to nascent firms offering business and consumer products and services.

Two reports out this week show VCs last year cut investments to nearly all types of IT firms, except IT services. Ernst & Young/Venture One reported that VCs in 2005 invested nearly $12 billion in IT firms, down 4% from 2004. And PricewaterhouseCoopers' MoneyTree survey showed decreases in first-time funding in a number of IT sectors, including a whopping 75% drop for networking and equipment ventures.

But VCs aren't avoiding IT companies. What many would consider IT companies often are classified in other sectors. Take, for instance, a young Houston company called White Fence, which helps consumers sign up for electricity, gas, telephone, Internet, and other services. The company's services are offered through the Internet, but VentureOne classifies White Fence--which last month received $15 million in financing from the Internet Capital Group--as a consumer service, not an IT company.

VentureOne categorizes health-care management and analytic services provider Health Dialog--which received $171 million from six VCs last quarter, the most of any venture--within the health-care sector, even though IT serves as a main platform for its offerings. "I can barely find a[n industry] category that doesn't have a significant technology component," says Kirk Walden, PricewaterhouseCoopers' national director of venture-capital research.

Walden says the amalgamation of IT and business to create a new type of non-IT business began to accelerate as the dot-com bubble was set to burst. "While we were not looking," he says, "it pretty much happened."

But VCs haven't abandoned pure-play IT companies; indeed, the vast majority of investments go to info tech ventures. In 2005, 54% of VC investments ended in the coffers of IT ventures, compared with 30% for health care and 12% for products and services, VentureOne reports. "It's not as if everyone is shifting away from IT, but there are some other sectors like alternative energy, business services, and outsourcing that have drawn a little bit of interest away from IT," says VentureOne research analyst Josh Grove.

The proportion of VC investments in non-IT products and services ventures grew last year by 3 percentage points, while IT's and health care's shares slipped 4 percentage points and 2 percentage points, respectively. IT's share of the VC investment pie peaked in 2001 at 65%, according to VentureOne.

Within the IT sector, investments in IT services, the hottest IT category, rocketed by 20% last year to $1.11 billion, VentureOne reports. The biggest plunge was in electronics, which plummeted 19% to $1.14 billion. The most money went to software ventures, which received $5.1 billion, down 10% from 2004. Other tech categories: communications, up 5% to $2.96 billion, and semiconductors, off 10% to $1.65 billion.

According to the MoneyTree survey, the amount of first-time institutional VC investments in information services companies last year soared 52% to $272.7 million, suggesting that investors see strength within this category in the coming years. First-time investments tend to be bigger risks, so with VCs putting so much money into information services, they'll need to wait for any potential profit.

"Venture capitalists are taking a longer view of that industry sector; they're willing to wait longer for an exit because they're getting in early," Walden says. "They have to be both willing to take risks and willing to be patient."

This story was modified on Jan. 25 to indicate that PricewaterhouseCoopers' MoneyTree survey showed a 75% drop in first-time funding for networking and equipment ventures.