Storage Sector Funding Hangs In
October 13, 2003

By James Klein, Larta VOX Editor

Despite the depressed VC funding climate of recent times, and a dismal period of corporate IT spending, storage networking has been a comparably robust sector for venture capital investment, according to a new report by independent technology analyst Graeme Thickins, published by Byte and Switch Insider.

The report is based on data from PricewaterhouseCooper's MoneyTree Survey and on additional research data from Byte and Switch, a site devoted to storage networking.

"With the growth in the volume of data in enterprises today, and the storage management problems that result, there remains a demand for new and better solutions from the industry," said Thickins, who's co-based in Minneapolis and San Clemente. "Despite the reduced IT spending climate and a slow economy, companies still must contend with growing storage management problems," he said.

It should be noted, however, that investment in the storage sector has dropped by about 50% compared with the previous year, and there is some concern that segments of the sector have been overfunded.

While other IT sector investing has slowed in recent months, the data storage industry continues to remain relatively healthy, albeit with investments favoring follow-on rounds as investors shy away from startups of all kinds.

A total of $1.12 billion was invested in 87 storage networking firms from the third quarter of 2002 through the second quarter of 2003, according to the report. Follow-on rounds of investment represented the vast majority of this past year's funding, with only 6% of VC money going to first-round.

"What's been interesting to me is just the fact that investors continue to fund new and existing startups in the storage space, in spite of the general acknowledgement that the space has been heavily funded," said Charles Beeler, managing partner at El Dorado Ventures.

Among storage networking startups, those in the hardware category saw the most activity, with 40 firms receiving $686.9 million in funding for 61% of total funding, as well as the highest average funding per company, $17.17 million. For the purposes of the report, the hardware category included companies providing storage arrays, storage networking switches, storage security appliances, RAID controllers, and InfiniBand switches.

Software storage startup companies represented the second most active sector, receiving $256.3 million, or $8.54 million average for the 30 companies in this part of the study. Companies considered to be in the software category included those providing backup and recovery, data replication, storage resource management (SRM), virtualization, file caching, archiving, and global file systems.

A detailed list of companies that received funding is included in the report, as well as an analysis of venture capital firms that provided the funding.

A similar report by Byte and Switch Insider, covering the same sectors and published around the same time last year, identified 106 companies that received funding and calculated total "private investment" in all storage networking categories at $2.89 billion. Funding in the past 12 months has therefore declined substantially in dollar volume, although the number of VC fundings (rounds) has held relatively constant.

Methodologies varied between the two years' studies, but the numbers indicate that VC funding dollars for storage networking dropped by more than half in the past twelve months, compared with the previous year.

An interesting result of the report is the number of companies that appeared on the previous year's list that also raised money this year. 34 companies made repeat appearances in the report, representing 39% of the 87 companies on this year's list. A large portion of VC funds therefore went to companies that have already established a foothold in the market and are meeting milestones, mirroring a general trend throughout the country, as technology companies of all kinds seeking Series A funding are having a hard time attracting capital. The report identified only seven early-stage startups receiving first-round funding during the period examined, receiving a total of $70.1 million.

"Startups today need verifiable customer traction. It's harder for new ideas; most funding today is later-stage stuff," said Jeff Hinck of Crescendo Ventures. "We look for companies that can get from zero to $15 to $25 million in revenues pretty quickly."

Signs are encouraging overall, though, according to Jay Hare, technology partner at PricewaterhouseCoopers, commenting on the technology venture funding environment in general. "With the rebound of Nasdaq, we've had both a 5% uptick in total dollars for all venture fundings as well as a meaningful uptick in the percentage of venture capital going into early-stage companies." Nasdaq gained 21% in the second quarter of 2003.

"During 2002, early-stage companies attracted approximately 19% of all venture dollars. In Q2 of 2003, a four-quarter trends of continuous declines ended when the early-stage companies attracted 22.3% of all dollars, up from 16.5% in Q1 2003," continued Hare.

More evidence of positive trends is found in the MoneyTree survey data. At the end of 2002, storage network deals attracted approximately 4.6% of total dollars nationwide. In 2003 so far, the sector is surpassing that figure, with approximately 6.1% of the total dollars nationwide going to storage networking deals, according to Jennifer Hacker Olsen, PricewaterhouseCooper's Twin Cities office MoneyTree survey coordinator. For the full year studied in the Byte and Switch Insider report, storage networking deals attracted 5.3% of total venture dollars nationwide.

The Byte and Switch Insider survey data reveals that California companies received the highest percentage of investments compared to other states. California companies attracted $468 million, or 42% of the total investments nationwide.

According to the Byte and Switch Insider report, sectors within the hardware industry that bare watching include IP SANs, which had several strong startups. Data protection/backup/disaster recovery was the hottest software storage sector, followed by storage resource management (SRM), system area management (SAM), and storage virtualization software.

More than a few analysts and VCs note, however, that the some software areas are overfunded and consolidation is already underway. A noticeable trend developed this past year in services as well: there was a strong showing of support from VCs for online backup services.

What's in store for the second half of 2003 and early 2004? According to the report, it is expected that VCs will continue to be cautious, making selective new investments and nurturing their existing companies. But some VCs are more positive.

"We believe storage will be a growth sector for the IT industry," said Scott Sandell, a partner at VC firm New Enterprise Associates. "And, given the remaining unsolved problems, we expect it to be a fertile area for innovation. That said, the opportunities to build large new storage companies are fewer than five or six years ago, because the larger vendors have become more aggressive in pursuing new opportunities."

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