Playing favorites: just what type of company is the apple of a venture capitalist's eye?

Entrepreneur, April, 2003 by Julie Monahan

WHILE ECONOMIC ATRO-phy has given pause to risk-loving venture capitalists, software remains a soft spot for many investors. Venture funding slumped to its lowest level in four years in the third quarter of 2002; still, software companies enjoyed a 28 percent boost compared to the same period a year ago. That increase amounted to $1.2 billion in venture capital for the sector, according to consulting firm Ernst & Young and research firm VentureOne. Altogether, software companies accounted for 35 percent of venture capital in the quarter.

"Software companies are easier to fund because they don't have a lot of inventory risk," says John Copeland, founder, chair and chief scientist of Lancope, a network security firm in Atlanta His company received $5.5 million in VC funding last April. Having a solid sales record helps, too, Copeland says: "Our funder wanted a product that was proven in the marketplace, [not] just a company with a great idea."

Anne Mitchell sees another advantage. "For software companies, it's easy to be light on your feet," says Mitchell, founder, president and CEO of Habeas Inc., an anti-spam software firm in Palo Alto, California. "If something [must be] changed, it can be implemented in 24 hours." Venture capital helped launch Habeas last August.

The Ernst & Young study also found that when venture capitalists fund, they are investing at higher amounts. "The better companies are being funded," says Bryan Pearce, VC advisory group leader at Ernst & Young in Boston. "And they're getting more than they have in the past."

As investors look for more stable opportunities, franchise companies in service sectors such as food are also getting a closer look. This interest has been long in coming, says Don DeBolt, president of the International Franchise Association: "It's taken the financial community a while to understand a successful company isn't always built on hard assets."