Telecom reform, 'Net fuel venture funding

Network startups fueled a record amount of venture capital investments during the third quarter, according to an exclusive Price Waterhouse/Network World survey.

Driving high-tech investment activity are start-ups attempting to exploit markets opened up by telecom reform, Internet companies receiving later-stage funding and all manner of wireless product and server vendors.

Total investments in all start-ups in this year's third quarter reached $3.57 billion, topping the previous high of $3.18 billion, reported in the second quarter, according to the Price Waterhouse Venture Capital Survey released last Thursday.

Of the 675 companies receiving venture funding in the third quarter, 168 reported a network technology element in their business.

Those firms were given $933 million in funding, about 41% of the $2.25 billion total invested in high-tech firms.

Among the types of companies drawing the most interest from investors in the third quarter were wireless communication vendors, high-speed switch and router providers (YAGO Systems, Inc. grabbed $4.9 million and Foundry Networks, Inc. bagged $9 million) and remote access upstarts (RAScom, Inc. snagged $10 million and New Oak Communications, Inc. is $7.5 million richer).

Also hot were Internet access and software start-ups, such as Sitara Networks, Inc., which received $7 million in second-round funding to help deliver its software for speeding Web site access. Other emerging Internet markets include electronic commerce products and software for bringing legacy applications to the 'Net.

Investments in communications companies, including firms that sell hardware such as switches and routers or provide services such as remote access and local phone service, topped software investments last quarter for the first time, $797 million to $794 million. Usually, "communications is about 20% below software," said Kirk Walden, Price Waterhouse Venture Capital Survey director.

Start-ups spawned by telecom reform clearly are driving the communications category as a whole," he said.

The main reason for the rush of activity in telecommunications is the market created by the 1996 federal law forcing local carriers to allow competition.

"Telecom reform opened up a $100 billion market that before was totally monopolized," said Todd Dagres, a partner at Battery Ventures, a venture capital firm in Wellesley, Mass. "Twenty percent of that market will go to competitive local exchange carriers. That's $20 billion over the next five years."

Battery Ventures invested in two local exchange start-ups in the third quarter - XCOM Technologies, Inc. of Cambridge, Mass. and Allegiance Telecom, Inc. of Dallas.

These phone networks are largely aimed at carrying Internet and corporate data traffic, Dagres said. "That's why second lines are being added, and why higher performance access is required, and why bigger backbones are needed," he said.

Telecom companies also at-tracted some of the largest venture investments in the third quarter because of the high costs of gaining a foothold in that sector.

"Some of the telecom start-ups, such as fiber-optic companies, require a chunk of money," Walden said. "You're not talking about a $5 million seed investment like you'd see with a software start-up."

For example, Formus Communications, Inc., of Englewood, Colo., a developer of broadband wireless systems, received $30 million in first-round funding from four different venture firms. And Allegiance Telecom was given $19 million in second-round capital from Battery Ventures and three other partners.

In contrast, early-stage start-ups overall averaged $4 million each.