Where the money is: VCs pour cash into software startups

Think there’s nothing new under the sun when it comes to file management and database software? What about that old warhorse, ERP? You may consider those segments passé, but the venture capital community disagrees. In the first quarter of 2012, just under $147 million and $118.6 million in venture capital money flowed respectively to startups in those areas.

The renewed interest by VCs in database and file management startups is part of a larger revival in funding for software. In each of the last five quarters, venture money for software startups has increased when compared to the same quarter in the previous year, according to data compiled by the National Venture Capital Association and PricewaterhouseCoopers.

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Of the $5.8 billion invested in startups last quarter, $1.6 billion (about 28 percent of the total) went to software. What’s behind the money rush? Two major factors, says Mike Gualtieri, a principal analyst at Forrester Research, are (1) the need for companies to move faster to satisfy consumers who are increasingly willing to abandon known brands and (2) the ever-growing demand for mobile services. “Increased consumer choice and voice [meaning employees’ increased advocacy for what they want] require more flexible internal IT systems.”

Not surprising, that flow of money is creating a flood of jobs. As I reported a few months ago, more than 14,000 jobs are waiting to be filled at startups, including thousands for software engineers and developers.

Social media investments fall off the cliff Software was not riding a tide that floated everyone’s boat in the quarter — just the opposite, in fact. Overall venture funding was off by some 18 percent (depending on whose stats you use) when looked at by capital raised, while the number of deals was down by 9 percent year over year.

“The declines were pretty evenly spread across industries, so there weren’t any big winners or big losers in the quarter, but there were some surprises. Investment in consumer Internet companies fell after two exceptional investment years, while the IT industry fared well thanks to strong interest in software startups,” says Jessica Canning, global research director for Dow Jones VentureSource.

In fact, it appears that interest by VCs in consumer Internet companies fell off a cliff, dropping by about 75 percent to $375 million, VentureSource found. The sector includes areas that have been smoking hot, such as social media, entertainment, and shopping aggregators. “I see some people looking at the enterprise space again, probably as a reaction to areas like social being overcapitalized,” says Bob Ackerman, managing director at Allegis Capital, which invests heavily in enterprise companies. (Ackerman made his comments to reporters from ReadWriteWeb.com.)

Facebook’s disappointing IPO is another prominent sign that Wall Street and Silicon Valley’s Sand Hill Road (ground zero for the VCs) are finally becoming more skeptical about the long-term earnings prospects for social media. That’s not to say the sector will collapse, of course. But if the money people decide to back off on social, we may well see more money flowing to other technology segments, including enterprise-oriented software and services.

Information technology as a whole was the only major industry that saw a year-over-year increase for both deals and capital raised. IT companies raised $2 billion through 257 deals, a 14 percent increase in capital invested and a 2 percent increase in deals.

IT-related companies other than software included IT services, which garnered $347 million in 69 deals, or 6 percent of the total capital raised; semiconductors at 26 deals for $199 million; telecommunications at $172 million and 21 deals; and networking at 11 deals for $67 million.

(I’m doing a little mixing and matching in this post, drawing numbers from NVCA and VentureSource. Their tallies are usually pretty close to each other, but not identical, so there are a few inconsistencies here. The trends, though, are very clear.)

What’s hot in software Five segments in the software industry gained nearly half of the $1.6 billion raised by the sector. They were recreational and game software ($208 million), industry-specific software ($157 million), business and office software ($151 million), database and file management software ($147 million), and ERP/inventory software ($119 million).

Although cloud computing is not broken out as a separate segment, Forrester’s Gualtieri says it is driving innovation — and funding — in software. For example, NoSQL, a distributed (instead of relational) database makes it much easier to change the structure of data and distribute it across multiple nodes, he says. “Interest in NoSQL is driven by the cloud and the need to change applications much faster.”

Platform as a service (PaaS) is another driver of the software renaissance. “What we’re seeing is a real need and opportunity to increase developer productivity,” Gualtieri says. And smaller companies are leading the way: WaveMaker, for example, was purchased by EMC VMware last year. Other such providers include OutSystems and Mendix. It’s worth noting that Mendix has a number of jobs posted on its website, as does Outsystems.

Isn’t it great to see money moving to areas where it will fund useful technologies, along with good jobs?

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