Venture Capital Invesment in IT Startups on the Rise in 2006
By Priya George
The rapid development of the digital economy during the last half of the 1990s was made possible by matching investment capital with revolutionary new ideas. The Information Technology (IT) sector, in particular, benefited from the support of private venture capital firms, which provided about USD 5 billion to start-ups in 1995 and almost USD115 billion five years later. By the end of 1999, these investments were concentrated in Internet start-ups stimulated by the profits reaped from Initial Public Offerings (IPOs) of Internet-related companies.
The IT sector has had a major impact on US economic performance starting in the mid-1990s. From 1995 to 2000, real gross domestic product (GDP) increased at an annual rate of over 4 percent, up from 2.37 percent for the first half of the decade. During the same period, labor productivity, the source of higher wages and better living standards, increased at 2.5 percent annually, nearly double the pace of the previous 25 years.
But just as the IT and telecom sectors played a disproportionate role in the economic expansion of the 1990s, they also played a prominent role in the ensuing economic slowdown. The collapse of the IT sector preceded, and to a large extent drove, the general economic slowdown of 2001. IT investment spending declined, share values fell precipitously, dozens of prominent firms went bankrupt, and hundreds of thousands of jobs were lost. Between 2001 and 2004, however, the rate of GDP growth increased each year, growing at 4.2 percent in 2004.
GDP grew at a still respectable 3.5 percent in 2005 and a strong 5.6 percent in the first quarter of 2006,2 though the Federal Reserve predicts that economic growth will be between 3.25 percent and 3.5 percent for all of 2006 and between 3 and 3.25 percent for 2007.
Although the IT sector is not growing as fast as it did in the late 1990s, it has been growing consistently over the past several years, and has played an important role in overall economic growth. In fact, there has been even faster average growth in overall US productivity from 2000 to 2004 (2.8 percent) than from 1995 to 2000 (2.3 percent).4 Stock indices for the IT industry and its component sectors exhibit slow but steady growth, indicating that the IT sector has been expanding at a healthy rate.
Funding for New Ideas
Venture capitalists have historically provided the seed money for companies with new ideas. For successful start-ups, IPOs have provided additional capital to finance expansion and growth, as well as large payoffs to early investors. In the last half of the 1990s, the IT sector accounted for an unusually large portion of both venture capital financing and IPOs, though activity in both areas declined dramatically in 2000. Venture capital investment leveled off in 2003 and since then has slowly increased.
The software and biotechnology industries were the recipients of the most venture capital in 2005, but their shares of the total declined. The telecommunications industry exhibited growth, driven by the wireless subcategory: in 2005, 152 wireless-related companies received USD 1.3 billion in venture capital, a 24-percent increase over the USD 1.1 billion they received in 2004.
Worldwide, from January through November 2005, USD 138.5 billion was raised by 1268 IPOs, exceeding the USD 124 billion raised during all of 2004.
In the first quarter of 2006, the amount of venture capital invested in the IT sector was consistent with levels of the previous year; in cases where the level of venture capital funding was made public, total investments in the first quarter of 2006 were USD 3.01 billion, compared with USD 3.19 billion in the first quarter of 2005.
Public market financings for technology companies based outside the US are rising and making up a growing percentage of total technology financings. Morgan Stanley estimated that the percentage of technology financings accounted for by companies based outside the US in 2005 was 65 percent, compared with 58 percent in 2004, 51 percent in 2003, and 39 percent in 1998.
In 2005, there were 56 venture-backed IPOs (down from 93 in 2004), which raised a total of USD 4.5 billion. The reduction in IPOs can be attributed at least partially to hurdles associated with the Sarbanes-Oxley Act.
According to the National Venture Capital Association, in 2005, the IT sector had 26 venture-backed companies raising a total of USD 2.6 billion. The Internet Specific category was responsible for ten of those, amounting to USD 1.3 billion.
Investment in IPES (information processing equipment and software) has been about 25 percent of total private fixed investment since 1998, peaking at 27.8 percent in 2000. Investment in IPES increased to USD 488.9 billion in 2005, but did not increase by as much as investment in other sectors, resulting in a somewhat lower 23.4-percent share of total private fixed investment than in the past several years.
The Future of the Digital Economy
The outlook at the beginning of 2006 was generally positive, with a survey of worldwide business executives demonstrating an increase in confidence about their respective industries and national economies—the first time executive confidence in the global economy had risen for two years.
