Software Tops VC Spending List

Call it the VMware effect.

Venture capitalists looking for the next big score invested more than $1.5 billion in fledgling software companies in the second quarter, according to the latest figures from The MoneyTree Report by PricewaterhouseCoopers and the National Venture Capital Association.

Total venture capital spending rose to $7.1 billion in the quarter, the most since the third quarter of 2001.

For the first time in more than a year, software companies garnered more venture capital than any other industry sector. Biotechnology investments checked in second at $1.17 billion in the quarter, followed by medical devices and equipment and telecommunications at $995 million and $476 million, respectively.

This renewed enthusiasm for software upstarts was largely fueled by increased awareness and demand for virtualization software, software-as-a-service (SaaS)  models and open source applications.

“Software is a very, very hot space right now,” Laura McCaughey, managing director of AMR Research’s investment research strategies group, told InternetNews.com. “As people try to take their businesses to the next level, they’ve found that implementing terrific software and processes has a direct correlation to improved profitability.”

McCaughey said venture capitalists closed 247 deals with software firms last quarter, the most since 2001. Security, content management, system management and customer relationship management (CRM)  application vendors were particularly popular with the Sand Hill Road crowd.

“Also, it’s a very strong IPO market right now relative to how it has been,” she said.

VMware’s  blockbuster initial public offering, as well as a flurry of mergers and acquisitions by enterprise software leaders Oracle  and SAP  , have helped convince venture capitalists to open their wallets, McCaughey said.

In the past two months, Oracle snapped up Bharosa, a provider of fraud prevention and authentication security software, and Bridgestream, which makes software that maps relationships within an organization, to round out its Identity Management software suite.

In May, SAP acquired OutlookSoft, a developer of planning, budgeting and consolidation software, and Wicom Communications, an all-IP contact center and enterprise communications software vendor.

Software companies conducted a total of 408 mergers and acquisitions in the second quarter, proving that large software vendors are more than happy to pay a premium to acquire specialized applications and services to satisfy their customers’ business needs.

Denis Pombriant, an analyst at Beagle Research Group, said companies for years had come to rely on increased processing power to improve productivity throughout their organizations. Now, he said, businesses are looking for the software equivalent of Moore’s Law to spark efficiency and innovation.

“The analogy I like to make is that if you’re a driver, you don’t need to know how fuel injection works,” he said. “You just need to know how to drive. Software applications that are really simple to define and use enable companies to build business rules and processes to support relatively complex and potentially global business processes.”

Total venture-capital spending peaked at $12.8 billion in the first quarter of 2001, just ahead of the dot-com implosion, before falling to just $4.3 billion in the first quarter of 2003.